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21 - Other path finders
Nouriel Roubini: Face of the crisis
“He’s been the most right of all the economists around,” - George Soros
Before this, he earned his PhD from Harvard, working in the economics department at Yale and spending two years as a policymaker in Washington, including serving as senior adviser to Tim Geithner, then an undersecretary at the Treasury.
Dr Doom, the professor who predicted the crisis.
(born on March 29, 1958 in is a professor of economics at New York University. He is also the chairman of RGE Monitor, an economic and financial analysis firm.
Two years ago, Nouriel Roubini predicted the current economic crisis. Now he sees things becoming far worse. BY STEPHEN MIHM August 15, 2008, New York Times Sunday Magazine
On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.
The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed — and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market. And then there was the espouser of doom himself: Roubini was known to be a perpetual pessimist, what economists call a “permabear.” When the economist Anirvan Banerji delivered his response to Roubini’s talk, he noted that Roubini’s predictions did not make use of mathematical models and dismissed his hunches as those of a career naysayer.
It appears almost everything Dr Doom describe here has eventuated by Oct 2008. The only variance is that the speed of these events unfolding is faster that Dr Doom’s prediction. On the front, Dr Doom appears “too optimistic!”. Eg. he said it takes 2 years for those investment back to fold, actually it only took 7 months. All big 5 individual Investment bank fell.
- The Roubini prophecy
The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster
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Nouriel Roubini Feb 5, 2008
Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.
To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.
That is the reason the Fed had thrown all caution to the wind – after a year in which it was behind the curve and underplaying the economic and financial risks – and has taken a very aggressive approach to risk management; this is a much more aggressive approach than the Greenspan one in spite of the initial views that the Bernanke Fed would be more cautious than Greenspan in reacting to economic and financial vulnerabilities.
To understand the risks that the financial system is facing today I present the “nightmare” or “catastrophic” scenario that the Fed and financial officials around the world are now worried about. Such a scenario – however extreme – has a rising and significant probability of occurring. Thus, it does not describe a very low probability event but rather an outcome that is quite possible.
Start first with the recession that is now enveloping the US economy. Let us assume – as likely - that this recession – that already started in December 2007 - will be worse than the mild ones – that lasted 8 months – that occurred in 1990-91 and 2001. The recession of 2008 will be more severe for several reasons: first, we have the biggest housing bust in US history with home prices likely to eventually fall 20 to 30%; second, because of a credit bubble that went beyond mortgages and because of reckless financial innovation and securitization the ongoing credit bust will lead to a severe credit crunch; third, US households – whose consumption is over 70% of GDP - have spent well beyond their means for years now piling up a massive amount of debt, both mortgage and otherwise; now that home prices are falling and a severe credit crunch is emerging the retrenchment of private consumption will be serious and protracted. So let us suppose that the recession of 2008 will last at least four quarters and, possibly, up to six quarters. What will be the consequences of it?
Here are the twelve steps or stages of a scenario of systemic financial meltdown associated with this severe economic recession…
20 - IMF
CAPITALIZING ON THE CRISIS
RETURN OF THE IMF Laurence Neville http://www.gfmag.com/index.php?idPage=1073
Having avoided the headlines for years, the International Monetary Fund found itself squarely in the spotlight in October as it made a series of emergency loans to Hungary, Iceland and Ukraine.
In addition to flexibility on conditionality, there are other signs of new thinking by the IMF. At the end of October it announced a new Short-Term Liquidity Facility that will deliver funds to countries deemed to be responsibly managed almost immediatel and, crucially, with no conditions梚f they are hit by financial turbulence. 揟he IMF has had a long discussion about contingent credit lines and how to make them available without creating a stigma and risking that country抯 stability as well as ensuring some minimum degree of conditionality so that countries do not stray from responsible macro policies,?explains Barcap抯 Keller. 揟he Short-Term Liquidity Facility announced recently appears to meet these needs: Countries are pre-qualified so that help is immediate, and it is a confidential process, so there should be no market fallout.?br />
Countries will be able to borrow up to 500% of their quota through the Short-Term Liquidity Facility梒ountries?quotas are related to their size in the global economy梞eaning that Brazil, for example, could borrow up to $22.5 billion. Loans are for three months at regular IMF interest rates and can be renewed twice within a 12-month period.
Role of the saviors
If the US was a Third World country, the IMF would be called in to run the economy. Debts would go into default, uneconomic companies and projects would be allowed to fail, putting people out of work and interest rates would shoot up. - Dow Will Equal Gold in 2009 Peter Cooper Dec 4 seekingalpha
The International Monetary Fund (IMF) came into official existence on December 27, 1945, when 29 countries signed its Articles of Agreement at a conference held in Bretton Woods, New Hampshire, USA, from July 1-22, 1944. The IMF began financial operations on March 1, 1947.
Source of funds:
Capacity:
IMF Global Financial Stability Report, October 2008 (GFSR):
RGE monitor: The IMF faces two big problems. First, its capital base is small relative to the size of global capital flows... A lending capacity of $250bn doesn’t amount to much in a world of $700bn bailouts and cross-border capital flows amounting to trillions of dollars. It is not easy for the IMF to raise capital — the begging bowl has to be taken around to all its member countries. One recalcitrant member such as the US can block the whole plan.
Second, the IMF has a huge credibility problem. It is seen as mostly taking orders from the US. The voting structure gives the US, which has a 17 per cent share, a veto over important decisions that require an 85 per cent super-majority. Meanwhile, even large emerging economies such as China and India have modest shares of 3.5 and 2 per cent respectively. But “governance” reforms to set right such imbalances have been fraught and painfully slow as redistribution of voting rights is a zero sum game.
By BOB DAVIS, MARCUS WALKER and JOHN LYONS – WSJ 30 Oct
The International Monetary Fund will offer as much as $100 billion in a new kind of loan to countries that are battered by the financial crisis, making available new cash to help ease the world credit crisis.
The new three-month loans, aimed at economies the IMF judges to be troubled but basically sound, wouldn't require countries to make the often severe changes in their policies that the IMF has demanded for decades.
That makes it potentially easier for crisis-hammered countries such as Mexico, Brazil and Korea to shore up cash reserves, their currency, and their ability to help ailing companies as shaken foreign investors withdraw.
Those countries have shunned the IMF because of the strings attached to the loans, which often force sharp budget cuts or interest-rate increases. The conditions are designed to help governments save money and pay for necessary imports, but they also often deepen an economic downturn, making the IMF deeply unpopular around the world.
Now it essentially is dividing developing countries into an A-list of nations that qualify for loans without strings, and a B-list of everyone else.
Late Tuesday, the IMF unveiled a $25 billion package of loans organized for Hungary. That package and a $16.5 billion loan for Ukraine require painful belt-tightening in exchange for help. Hungary must cut its budget deficit further, plans to cut bonus payments to retirees and public-sector workers, and predicted on Tuesday that the economy would shrink by as much as 1% next year.
The new program, which will use up to about half the IMF's resources, represents a big break
The Fed also took new steps to flood dollars into markets outside the U.S., where banks' unwillingness to lend has left foreign firms without dollars they need. In recent weeks, the Fed has created arrangements with central banks in Europe, Australia, Canada and other developed economies to make dollars available overseas. On Wednesday, it extended those lines, for up to $30 billion each, to Brazil, Mexico, Korea and Singapore.
The two moves underscore deepening problems in developing nations, which have sent currencies plunging and blown holes in the balance sheets of healthy companies. In recent days, Brazil's financial capital of São Paulo has been awash in speculation that the plunging currency and lack of dollar financing could spur a wave of corporate defaults that might even bring down key parts of the financial system.
The IMF said it won't disclose the names of countries that it rejects for condition-free loans to try to make sure its decision doesn't worsen the applicant's problems. But Mr. Strauss-Kahn said in a news conference that Argentina wouldn't qualify because it hasn't had an IMF review of its finances for more than a year. Argentina is also on the outs with many lenders because it defaulted on its loans in 2001 and offered only partial repayment, which many borrowers considered inadequate.
The program would offer three-month loans of as much as five times a country's so-called quota, meaning its financial stake in the IMF. Mexico, for instance, has a quota of $4.75 billion, so it could borrow as much as $23.6 billion. Borrowers can renew their loans twice during a year.
The IMF is funded by contributions from its members and its large holdings of gold, among other sources. By itself, IMF money might be enough for the needs of Mexico or other countries. IMF funding also can often unlock other lending. The World Bank, for instance, chipped in $1.3 billion for the Hungary package. The World Bank has said it may double its lending to countries that might be affected by the financial crisis to $27 billion from $13.5 billion in 2007.
In many ways, the new plan is a reprise of a proposal by President Bill Clinton in late 1998 to have the IMF lend to pre-approved countries. That was in response to criticism of the IMF by countries caught up in the Asia financial crisis in 1997 and 1998 in which IMF pushed them to make deep economic changes. Tough IMF requirements in Indonesia, for instance, played a role in violent riots that led to President Suharto's resignation. Korea, however, still may have little interest in the new arrangements. Koreans view the fact they needed IMF help a decade ago as a national humiliation.
Mr. Strauss-Kahn said the IMF is trying to learn the lessons from the Asia crisis and is limiting its demands for change even for its traditional loans. IMF economists should pick policy changes necessary "to make a program a success," he said, not to remake the economy
IMF's new liquidity facility in which countries can borrow up to 5 times their quota, with a three month duration, comes without specific conditions and is front-loaded rather than delivered in tranches. But other countries will receive packages to encourage a more significant policy adjustment given that past policies contributed to their vulnerabilities.
Strauss-Kahn: "We are offering some countries substantial resources, with conditions based only on measures absolutely necessary to get past the crisis and to restore a viable external position"
IMF: Countries with a good track record of sound policies, access to capital markets and sustainable debt burdens (public and private sector) may qualify. Policies should have been assessed very positively by the IMF's most recent country assessment. with a three month maturity. Eligible countries are allowed to draw up to three times during a 12-month period
FDIC – RGE Can FDIC handling the banking bust?
Nov 22: Seizure and sale of Downey Financial Corp. and two smaller lenders may cost the FDIC more than $2 billion--> federal deposit insurance fund declines from $45bn to $43bn.
On October 7, FDIC proposes to more than double premiums that banks pay to fund the deposit insurance fund: Starting January 1, 2009, banks would have to start paying from 12 cents to 50 cents per $100 of deposits. They now pay from 5 cents to 43 cents. Agency also expects bank failures will cost the FDIC's deposit insurance fund about $40 billion from 2008 to 2013, with almost $13 billion of that amount used this year.
In Q2 FDIC reports $4'462bn insured domestic deposits out of $7'036bn total domestic deposits--> only 63% of domestic deposits are insured. By law, the FDIC maintains a rainy-day fund (i.e. reserves) equal to 1.25 percent of the level of insured deposits. After IndyMac's failure and others in the past quarter, the federal deposit insurance fund declined from $53 billion to $45 billion. Fund is invested in ultra-safe Treasuries.
Sep 25: WaMu is the largest bank failure in the U.S. and the 13th FDIC takeover this year and the 15th since the crisis startet. JPMorgan assumes all deposits and with no additional costs to the FDIC.
FDIC troubled bank list increases to 117 in Q2 from 90. Total assets of troubled banks jumped from $26 billion to $78 billion in Q2 (incl. $36bn from IndyMac). On average, 13% of banks that make the list fail.
August 11: FDIC plans to increase premiums after IndyMac failure (no new fee established yet.), although this will hurt banks precisely at the wrong time--> premiums could rise to 10 to 15 cents per $100 of domestic deposits from the current 5 to 7 basis points premium for most institutions (American Banker). In comparison: all institutions had to pay 23 basis points in the wake of the savings and loan crisis.
If necessary, the agency can also tap a $30 billion line of credit at the Treasury Department and borrow up to $40 billion from the Federal Financing Bank to cover assets at failed banks.
Whalen (IRA via SF Gate): Our analysis puts roughly 8% of all FDIC insured institutions in the stressed category as of Q1 2008 and roughly that same number headed in that direction. That 8% of all US banks translates into over 700 institutions as of Q1 2008. At the end of March, the FDIC had 90 institutions on its troubled institution list.
Whalen (RGE FinanceMonitor): By July 2009, we estimate the number of US banks likely to fail at 110 and total assets of said failed banks at $800 billion.
RBC (via MarketWatch), May 27: If U.S. slips into recession on the scale of those from the 1980s and early 1990's, the number of failures will be probably as high as 300.
Jones/Oshinsky (FDIC): The insolvency risk to the bank insurance fund has increased significantly due to industry consolidation, and is mainly due to the concentration of deposits in the ten largest U.S. banking companies. We also find that recent deposit insurance reforms will cause only a marginal reduction in the risk of the banking insurance fund insolvency. The increased risk associated with a more concentrated industry structure simply dominates the reform effect.
Slate: The FDIC was created, over the vociferous opposition of its beneficiaries—the banking industry—in the dark spring of 1933, when 4,000 banks had closed. In 75 years, no insured deposit—the current limit for a regular account is $100,000—has been lost, even in the lean years between 1986 and 1992, when 2,304 institutions went bust.
RETURN OF THE IMF Laurence Neville http://www.gfmag.com/index.php?idPage=1073
Having avoided the headlines for years, the International Monetary Fund found itself squarely in the spotlight in October as it made a series of emergency loans to Hungary, Iceland and Ukraine.
In addition to flexibility on conditionality, there are other signs of new thinking by the IMF. At the end of October it announced a new Short-Term Liquidity Facility that will deliver funds to countries deemed to be responsibly managed almost immediatel and, crucially, with no conditions梚f they are hit by financial turbulence. 揟he IMF has had a long discussion about contingent credit lines and how to make them available without creating a stigma and risking that country抯 stability as well as ensuring some minimum degree of conditionality so that countries do not stray from responsible macro policies,?explains Barcap抯 Keller. 揟he Short-Term Liquidity Facility announced recently appears to meet these needs: Countries are pre-qualified so that help is immediate, and it is a confidential process, so there should be no market fallout.?br />
Countries will be able to borrow up to 500% of their quota through the Short-Term Liquidity Facility梒ountries?quotas are related to their size in the global economy梞eaning that Brazil, for example, could borrow up to $22.5 billion. Loans are for three months at regular IMF interest rates and can be renewed twice within a 12-month period.
Role of the saviors
If the US was a Third World country, the IMF would be called in to run the economy. Debts would go into default, uneconomic companies and projects would be allowed to fail, putting people out of work and interest rates would shoot up. - Dow Will Equal Gold in 2009 Peter Cooper Dec 4 seekingalpha
The International Monetary Fund (IMF) came into official existence on December 27, 1945, when 29 countries signed its Articles of Agreement at a conference held in Bretton Woods, New Hampshire, USA, from July 1-22, 1944. The IMF began financial operations on March 1, 1947.
Source of funds:
Capacity:
IMF Global Financial Stability Report, October 2008 (GFSR):
RGE monitor: The IMF faces two big problems. First, its capital base is small relative to the size of global capital flows... A lending capacity of $250bn doesn’t amount to much in a world of $700bn bailouts and cross-border capital flows amounting to trillions of dollars. It is not easy for the IMF to raise capital — the begging bowl has to be taken around to all its member countries. One recalcitrant member such as the US can block the whole plan.
Second, the IMF has a huge credibility problem. It is seen as mostly taking orders from the US. The voting structure gives the US, which has a 17 per cent share, a veto over important decisions that require an 85 per cent super-majority. Meanwhile, even large emerging economies such as China and India have modest shares of 3.5 and 2 per cent respectively. But “governance” reforms to set right such imbalances have been fraught and painfully slow as redistribution of voting rights is a zero sum game.
By BOB DAVIS, MARCUS WALKER and JOHN LYONS – WSJ 30 Oct
The International Monetary Fund will offer as much as $100 billion in a new kind of loan to countries that are battered by the financial crisis, making available new cash to help ease the world credit crisis.
The new three-month loans, aimed at economies the IMF judges to be troubled but basically sound, wouldn't require countries to make the often severe changes in their policies that the IMF has demanded for decades.
That makes it potentially easier for crisis-hammered countries such as Mexico, Brazil and Korea to shore up cash reserves, their currency, and their ability to help ailing companies as shaken foreign investors withdraw.
Those countries have shunned the IMF because of the strings attached to the loans, which often force sharp budget cuts or interest-rate increases. The conditions are designed to help governments save money and pay for necessary imports, but they also often deepen an economic downturn, making the IMF deeply unpopular around the world.
Now it essentially is dividing developing countries into an A-list of nations that qualify for loans without strings, and a B-list of everyone else.
Late Tuesday, the IMF unveiled a $25 billion package of loans organized for Hungary. That package and a $16.5 billion loan for Ukraine require painful belt-tightening in exchange for help. Hungary must cut its budget deficit further, plans to cut bonus payments to retirees and public-sector workers, and predicted on Tuesday that the economy would shrink by as much as 1% next year.
The new program, which will use up to about half the IMF's resources, represents a big break
The Fed also took new steps to flood dollars into markets outside the U.S., where banks' unwillingness to lend has left foreign firms without dollars they need. In recent weeks, the Fed has created arrangements with central banks in Europe, Australia, Canada and other developed economies to make dollars available overseas. On Wednesday, it extended those lines, for up to $30 billion each, to Brazil, Mexico, Korea and Singapore.
The two moves underscore deepening problems in developing nations, which have sent currencies plunging and blown holes in the balance sheets of healthy companies. In recent days, Brazil's financial capital of São Paulo has been awash in speculation that the plunging currency and lack of dollar financing could spur a wave of corporate defaults that might even bring down key parts of the financial system.
The IMF said it won't disclose the names of countries that it rejects for condition-free loans to try to make sure its decision doesn't worsen the applicant's problems. But Mr. Strauss-Kahn said in a news conference that Argentina wouldn't qualify because it hasn't had an IMF review of its finances for more than a year. Argentina is also on the outs with many lenders because it defaulted on its loans in 2001 and offered only partial repayment, which many borrowers considered inadequate.
The program would offer three-month loans of as much as five times a country's so-called quota, meaning its financial stake in the IMF. Mexico, for instance, has a quota of $4.75 billion, so it could borrow as much as $23.6 billion. Borrowers can renew their loans twice during a year.
The IMF is funded by contributions from its members and its large holdings of gold, among other sources. By itself, IMF money might be enough for the needs of Mexico or other countries. IMF funding also can often unlock other lending. The World Bank, for instance, chipped in $1.3 billion for the Hungary package. The World Bank has said it may double its lending to countries that might be affected by the financial crisis to $27 billion from $13.5 billion in 2007.
In many ways, the new plan is a reprise of a proposal by President Bill Clinton in late 1998 to have the IMF lend to pre-approved countries. That was in response to criticism of the IMF by countries caught up in the Asia financial crisis in 1997 and 1998 in which IMF pushed them to make deep economic changes. Tough IMF requirements in Indonesia, for instance, played a role in violent riots that led to President Suharto's resignation. Korea, however, still may have little interest in the new arrangements. Koreans view the fact they needed IMF help a decade ago as a national humiliation.
Mr. Strauss-Kahn said the IMF is trying to learn the lessons from the Asia crisis and is limiting its demands for change even for its traditional loans. IMF economists should pick policy changes necessary "to make a program a success," he said, not to remake the economy
IMF's new liquidity facility in which countries can borrow up to 5 times their quota, with a three month duration, comes without specific conditions and is front-loaded rather than delivered in tranches. But other countries will receive packages to encourage a more significant policy adjustment given that past policies contributed to their vulnerabilities.
Strauss-Kahn: "We are offering some countries substantial resources, with conditions based only on measures absolutely necessary to get past the crisis and to restore a viable external position"
IMF: Countries with a good track record of sound policies, access to capital markets and sustainable debt burdens (public and private sector) may qualify. Policies should have been assessed very positively by the IMF's most recent country assessment. with a three month maturity. Eligible countries are allowed to draw up to three times during a 12-month period
FDIC – RGE Can FDIC handling the banking bust?
Nov 22: Seizure and sale of Downey Financial Corp. and two smaller lenders may cost the FDIC more than $2 billion--> federal deposit insurance fund declines from $45bn to $43bn.
On October 7, FDIC proposes to more than double premiums that banks pay to fund the deposit insurance fund: Starting January 1, 2009, banks would have to start paying from 12 cents to 50 cents per $100 of deposits. They now pay from 5 cents to 43 cents. Agency also expects bank failures will cost the FDIC's deposit insurance fund about $40 billion from 2008 to 2013, with almost $13 billion of that amount used this year.
In Q2 FDIC reports $4'462bn insured domestic deposits out of $7'036bn total domestic deposits--> only 63% of domestic deposits are insured. By law, the FDIC maintains a rainy-day fund (i.e. reserves) equal to 1.25 percent of the level of insured deposits. After IndyMac's failure and others in the past quarter, the federal deposit insurance fund declined from $53 billion to $45 billion. Fund is invested in ultra-safe Treasuries.
Sep 25: WaMu is the largest bank failure in the U.S. and the 13th FDIC takeover this year and the 15th since the crisis startet. JPMorgan assumes all deposits and with no additional costs to the FDIC.
FDIC troubled bank list increases to 117 in Q2 from 90. Total assets of troubled banks jumped from $26 billion to $78 billion in Q2 (incl. $36bn from IndyMac). On average, 13% of banks that make the list fail.
August 11: FDIC plans to increase premiums after IndyMac failure (no new fee established yet.), although this will hurt banks precisely at the wrong time--> premiums could rise to 10 to 15 cents per $100 of domestic deposits from the current 5 to 7 basis points premium for most institutions (American Banker). In comparison: all institutions had to pay 23 basis points in the wake of the savings and loan crisis.
If necessary, the agency can also tap a $30 billion line of credit at the Treasury Department and borrow up to $40 billion from the Federal Financing Bank to cover assets at failed banks.
Whalen (IRA via SF Gate): Our analysis puts roughly 8% of all FDIC insured institutions in the stressed category as of Q1 2008 and roughly that same number headed in that direction. That 8% of all US banks translates into over 700 institutions as of Q1 2008. At the end of March, the FDIC had 90 institutions on its troubled institution list.
Whalen (RGE FinanceMonitor): By July 2009, we estimate the number of US banks likely to fail at 110 and total assets of said failed banks at $800 billion.
RBC (via MarketWatch), May 27: If U.S. slips into recession on the scale of those from the 1980s and early 1990's, the number of failures will be probably as high as 300.
Jones/Oshinsky (FDIC): The insolvency risk to the bank insurance fund has increased significantly due to industry consolidation, and is mainly due to the concentration of deposits in the ten largest U.S. banking companies. We also find that recent deposit insurance reforms will cause only a marginal reduction in the risk of the banking insurance fund insolvency. The increased risk associated with a more concentrated industry structure simply dominates the reform effect.
Slate: The FDIC was created, over the vociferous opposition of its beneficiaries—the banking industry—in the dark spring of 1933, when 4,000 banks had closed. In 75 years, no insured deposit—the current limit for a regular account is $100,000—has been lost, even in the lean years between 1986 and 1992, when 2,304 institutions went bust.
19 - Federal Deposit Insurance Corporation
Chairman: Sheila C. Bair
In 1983, the Federal Deposit Insurance Corporation celebrated its 50th anniversary by issuing a history that began with this passage:
" 'On March 3 banking operations in the United States ceased. To review at this time the causes of this failure of our banking system is unnecessary. Suffice it to say that the government has been compelled to step in for the protection of depositors and the business of the nation.'
"As President Franklin D. Roosevelt spoke these words to Congress on March 9, 1933, the nation's troubled banking system lay dormant. More than 9,000 banks had ceased operations between the stock market crash in October 1929 and the banking holiday in March 1933. The economy was in the midst of the worst economic depression in modern history.
"Out of the ruins, birth was given to the FDIC three months later when the President signed the Banking Act of 1933. Opposition to the measure had earlier been voiced by the President, the Chairman of the Senate Banking Committee and the American Bankers Association. They believed a system of deposit insurance would be unduly expensive and would unfairly subsidize poorly managed banks. Public opinion, however, was squarely behind a federal depositor protection plan.
"By any standard, deposit insurance was an immediate success in restoring stability to the system. The bank failure rate dropped precipitously, with only nine insured banks failing during 1934. During the 30-year period beginning with World War II,the workings of the economy and the conservative behavior of bank regulators and the banking industry created a situation that posed few risks to the financial system, and the importance of deposit insurance in maintaining stability declined. Indeed, Wright Patman, the then-Chairman of the House banking committee, argued in a speech in 1963 that there were too few bank failures - that we had moved too far in the direction of bank safety. ''
In 1997, a follow up volume had a very different focus -- "the extraordinary number of bank failures in the 1980s and early 1990s.'' The wave of failures that came to be know as the savings and loan crisis and led to a reshaping of the F.D.I.C. and new attention to the importance of tight regulation of banks holding federally insured deposits.
Changes in the marketplace and in the legal landscape kept banking in turmoil, but few banks were failing. The collapse of the housing market and the credit crunch that followed in 2007 raised new worries, however, and by the spring of 2008 the F.D.I.C. was warning that the banking sector was facing alarming new strains. In July 2008 Indymac, a California-based bank, was seized by the agency as its mortgage-related losses mounted. Suddenly, the notices posted in financial institutions that they are "F.D.I.C. insured'' -- meaning that deposits are covered up to $100,000 -- were of interest again. – nytimes.com
FDIC was set up mainly to manage commercial bank failures. Deposit insurance legislation itself arose out of the bank failures of the early 1930s.
Why Sheila Bair wants to bail out consumers
The FDIC chief is the consistent voice of reason in her focus on homeowners as the key to saving the economy
By Betsy Morris, senior DECEMBER 12
For months, her agenda was a non-starter. Her proposals to try to turn distressed mortgages into performing loans through a loan modification program were getting absolutely no traction with either Federal Reserve chairman Ben Bernanke or Treasury Secretary Hank Paulson
As its list of problem banks swelled to 171 by the end of third quarter, up from 90 in the first quarter, its deposit-insurance fund fell to $34.6 billion, down from $52.8 billion. The agency has lines of credit with Treasury that it can tap if it ever came to that.
Congress has introduced proposed legislation to launch a loan-modification program, similar to her proposal, to be paid for with money from Hank Paulson's Troubled Asset Relief Program (TARP).
This wasn't the only recent show of support for Bair. In a speech last week to a Fed conference on housing and mortgage markets, Bernanke vindicated her position when he called for more aggressive action to stop foreclosures. One of his recommendations: the very loan-refinancing program instituted by Bair at IndyMac, the failed California bank, in which government will share some risk if a lender refinances to reduce monthly payments and keep the loan performing.
1.6 million mortgages are more than 60 days delinquent and the FDIC expects an additional 3.8 million of those next year. Home prices have fallen nationally by an average of 21% since peaking in the first quarter of 2006, according to the S&P/Case Schiller Home Price Index.
She's a pragmatist, aiming to prevent a deflationary spiral in housing prices that, along with accelerating job losses, will further devastate consumers, who are just as critical to a healthy economy as strong banks. Ironically, she's a Republican who has taken on the role of populist to restore confidence in the system. "I'm a capitalist. I believe in markets," she told an American Banker awards gathering last week.
The key difference to Fed Treasury
From the beginning of the crisis, she has been more focused on consumers than have Paulson, Bernanke or Geithner.
When Citi required a capital infusion last month, she stood firm about limiting the FDIC's exposure, according to a person knowledgeable with the negotiations, and attached some conditions, for example requiring Citi to modify troubled mortgages along the lines of IndyMac's program.
Her vigilance is less about ego than it is about protecting the FDIC and all that it stands for. Created by Congress in 1933 to restore public confidence in the nation's banking system, the agency is funded not by the government but by fees from the bank whose deposits it insures. So it's not a bottomless pit.
As its list of problem banks swelled to 171 by the end of third quarter, up from 90 in the first quarter, its deposit-insurance fund fell to $34.6 billion, down from $52.8 billion. The agency has lines of credit with Treasury that it can tap if it ever came to that.
In 1983, the Federal Deposit Insurance Corporation celebrated its 50th anniversary by issuing a history that began with this passage:
" 'On March 3 banking operations in the United States ceased. To review at this time the causes of this failure of our banking system is unnecessary. Suffice it to say that the government has been compelled to step in for the protection of depositors and the business of the nation.'
"As President Franklin D. Roosevelt spoke these words to Congress on March 9, 1933, the nation's troubled banking system lay dormant. More than 9,000 banks had ceased operations between the stock market crash in October 1929 and the banking holiday in March 1933. The economy was in the midst of the worst economic depression in modern history.
"Out of the ruins, birth was given to the FDIC three months later when the President signed the Banking Act of 1933. Opposition to the measure had earlier been voiced by the President, the Chairman of the Senate Banking Committee and the American Bankers Association. They believed a system of deposit insurance would be unduly expensive and would unfairly subsidize poorly managed banks. Public opinion, however, was squarely behind a federal depositor protection plan.
"By any standard, deposit insurance was an immediate success in restoring stability to the system. The bank failure rate dropped precipitously, with only nine insured banks failing during 1934. During the 30-year period beginning with World War II,the workings of the economy and the conservative behavior of bank regulators and the banking industry created a situation that posed few risks to the financial system, and the importance of deposit insurance in maintaining stability declined. Indeed, Wright Patman, the then-Chairman of the House banking committee, argued in a speech in 1963 that there were too few bank failures - that we had moved too far in the direction of bank safety. ''
In 1997, a follow up volume had a very different focus -- "the extraordinary number of bank failures in the 1980s and early 1990s.'' The wave of failures that came to be know as the savings and loan crisis and led to a reshaping of the F.D.I.C. and new attention to the importance of tight regulation of banks holding federally insured deposits.
Changes in the marketplace and in the legal landscape kept banking in turmoil, but few banks were failing. The collapse of the housing market and the credit crunch that followed in 2007 raised new worries, however, and by the spring of 2008 the F.D.I.C. was warning that the banking sector was facing alarming new strains. In July 2008 Indymac, a California-based bank, was seized by the agency as its mortgage-related losses mounted. Suddenly, the notices posted in financial institutions that they are "F.D.I.C. insured'' -- meaning that deposits are covered up to $100,000 -- were of interest again. – nytimes.com
FDIC was set up mainly to manage commercial bank failures. Deposit insurance legislation itself arose out of the bank failures of the early 1930s.
Why Sheila Bair wants to bail out consumers
The FDIC chief is the consistent voice of reason in her focus on homeowners as the key to saving the economy
By Betsy Morris, senior DECEMBER 12
For months, her agenda was a non-starter. Her proposals to try to turn distressed mortgages into performing loans through a loan modification program were getting absolutely no traction with either Federal Reserve chairman Ben Bernanke or Treasury Secretary Hank Paulson
As its list of problem banks swelled to 171 by the end of third quarter, up from 90 in the first quarter, its deposit-insurance fund fell to $34.6 billion, down from $52.8 billion. The agency has lines of credit with Treasury that it can tap if it ever came to that.
Congress has introduced proposed legislation to launch a loan-modification program, similar to her proposal, to be paid for with money from Hank Paulson's Troubled Asset Relief Program (TARP).
This wasn't the only recent show of support for Bair. In a speech last week to a Fed conference on housing and mortgage markets, Bernanke vindicated her position when he called for more aggressive action to stop foreclosures. One of his recommendations: the very loan-refinancing program instituted by Bair at IndyMac, the failed California bank, in which government will share some risk if a lender refinances to reduce monthly payments and keep the loan performing.
1.6 million mortgages are more than 60 days delinquent and the FDIC expects an additional 3.8 million of those next year. Home prices have fallen nationally by an average of 21% since peaking in the first quarter of 2006, according to the S&P/Case Schiller Home Price Index.
She's a pragmatist, aiming to prevent a deflationary spiral in housing prices that, along with accelerating job losses, will further devastate consumers, who are just as critical to a healthy economy as strong banks. Ironically, she's a Republican who has taken on the role of populist to restore confidence in the system. "I'm a capitalist. I believe in markets," she told an American Banker awards gathering last week.
The key difference to Fed Treasury
From the beginning of the crisis, she has been more focused on consumers than have Paulson, Bernanke or Geithner.
When Citi required a capital infusion last month, she stood firm about limiting the FDIC's exposure, according to a person knowledgeable with the negotiations, and attached some conditions, for example requiring Citi to modify troubled mortgages along the lines of IndyMac's program.
Her vigilance is less about ego than it is about protecting the FDIC and all that it stands for. Created by Congress in 1933 to restore public confidence in the nation's banking system, the agency is funded not by the government but by fees from the bank whose deposits it insures. So it's not a bottomless pit.
As its list of problem banks swelled to 171 by the end of third quarter, up from 90 in the first quarter, its deposit-insurance fund fell to $34.6 billion, down from $52.8 billion. The agency has lines of credit with Treasury that it can tap if it ever came to that.
18 - The US Treasury Department
Run by: Henry Paulson (2006-2009); succeeded by: Timothy F. Geithner
The Treasury Department traces its history back to the tumult of the opening days of the Revolutionary War, when a cash-strapped Continental Congress decided in 1775 to issue paper money backed by nothing more than the promise of eventual repayment in coin, and enlisted residents of Philadelphia to number and count the bills. The department was formally created by Congress in 1789. The first Secretary of the Treasury was Alexander Hamilton, who shortly after being appointed took the bold move of proposing that the federal government assume the wartime debt of the states and pay them off in full.
In the more than 200 years since, Hamilton's heirs have at times been among the most powerful figures in government, for better or worse. During the Civil War, Salmon P. Chase created the "greenback" paper currency that fueled the North's victory; Andrew W. Mellon helped bring on the Great Depression by his advice to President Hebert Hoover to cut spending and raise taxes during an economic downturn; after World War II, Henry Morgenthau, Jr., helped create a new system of international finance by leading the conference that created the International Monetary Fund and the World Bank.
President Clinton relied heavily on the advice of Robert E. Rubin, setting aside his desire for an economic stimulus package in favor of a mix of spending cuts and tax increases in 1993. Neither of President Bush's first two secretaries of the treasury, Paul O'Neill and John W. Snow, played much of a role in shaping administration policy, and both were pushed from office. Their successor, Henry M. Paulson Jr., saw his role increase along with the severity of the ills facing Wall Street after the mortgage market collapsed beginning in 2007. – nytimes.com
Fed vs Treasury
Tt's official: the Fed is monetizing government debt, Rebecca Wilder | Nov 27, 2008
The time has come to officially monetize government debt. Yesterday the Fed announced that it would purchase $100 billion in debt obligations from Fannie Mae, Freddie Mac and the Federal Home Loan Bank next week. And furthermore, it will purchase $500 billion in mortgage-backed securities (MBS) – I like to call this FARP (Fed Asset Relief Program).
The purchase of GSE debt is a direct attempt to reduce the spread on government agency (GSE) debt over comparable Treasury debt, the relative borrowing costs. Basically, the Fed is targeting a lower interest rate on GSE debt. Sound familiar? Yup, that’s monetizing government debt
The chart illustrates the difference between newly issued Fannie Mae debt and a comparable U.S. Treasury through 11/24/08. This spread has widened from an average of 29 bps (0.29%) spanning 2006-2007 to 90 bps spanning 2007-2008. Fannie Mae must pay more in order to finance its mortgage obligations, which limits its ability to roll over current obligations, and tightens the terms on new mortgage loans.
By driving down the spreads on GSE debt now, and later on mortgage-backed securities, the Fed gives the GSEs more flexibility in the mortgage market, and they can offer lower rates and better terms for potential homebuyers. That’s the theory.
Expect the Fed’s balance sheet to rise by another $100 billion (at least) in two weeks. It is official: the Fed is monetizing government debt.
Comment know, this is just step one. "Monetizing the Gov'ts debt" is just the same as buying outstanding obligations. Flooding the public with CASH.
Apparently this (monetizing) was necessary because of a "liquidity crunch". However, given a slight change in termiinology: This could also be seen as a "LOSS OF CONFIDENCE" in the "Government's" (Quasi) Debt (in the first place)!...Oh My God!
In this loss of confidence, step 2 is the loss in confidence of the dollar itself. Then we're all toast, except for our country's stockpiles of weapons and ammo!
The Treasury Department traces its history back to the tumult of the opening days of the Revolutionary War, when a cash-strapped Continental Congress decided in 1775 to issue paper money backed by nothing more than the promise of eventual repayment in coin, and enlisted residents of Philadelphia to number and count the bills. The department was formally created by Congress in 1789. The first Secretary of the Treasury was Alexander Hamilton, who shortly after being appointed took the bold move of proposing that the federal government assume the wartime debt of the states and pay them off in full.
In the more than 200 years since, Hamilton's heirs have at times been among the most powerful figures in government, for better or worse. During the Civil War, Salmon P. Chase created the "greenback" paper currency that fueled the North's victory; Andrew W. Mellon helped bring on the Great Depression by his advice to President Hebert Hoover to cut spending and raise taxes during an economic downturn; after World War II, Henry Morgenthau, Jr., helped create a new system of international finance by leading the conference that created the International Monetary Fund and the World Bank.
President Clinton relied heavily on the advice of Robert E. Rubin, setting aside his desire for an economic stimulus package in favor of a mix of spending cuts and tax increases in 1993. Neither of President Bush's first two secretaries of the treasury, Paul O'Neill and John W. Snow, played much of a role in shaping administration policy, and both were pushed from office. Their successor, Henry M. Paulson Jr., saw his role increase along with the severity of the ills facing Wall Street after the mortgage market collapsed beginning in 2007. – nytimes.com
Fed vs Treasury
Tt's official: the Fed is monetizing government debt, Rebecca Wilder | Nov 27, 2008
The time has come to officially monetize government debt. Yesterday the Fed announced that it would purchase $100 billion in debt obligations from Fannie Mae, Freddie Mac and the Federal Home Loan Bank next week. And furthermore, it will purchase $500 billion in mortgage-backed securities (MBS) – I like to call this FARP (Fed Asset Relief Program).
The purchase of GSE debt is a direct attempt to reduce the spread on government agency (GSE) debt over comparable Treasury debt, the relative borrowing costs. Basically, the Fed is targeting a lower interest rate on GSE debt. Sound familiar? Yup, that’s monetizing government debt
The chart illustrates the difference between newly issued Fannie Mae debt and a comparable U.S. Treasury through 11/24/08. This spread has widened from an average of 29 bps (0.29%) spanning 2006-2007 to 90 bps spanning 2007-2008. Fannie Mae must pay more in order to finance its mortgage obligations, which limits its ability to roll over current obligations, and tightens the terms on new mortgage loans.
By driving down the spreads on GSE debt now, and later on mortgage-backed securities, the Fed gives the GSEs more flexibility in the mortgage market, and they can offer lower rates and better terms for potential homebuyers. That’s the theory.
Expect the Fed’s balance sheet to rise by another $100 billion (at least) in two weeks. It is official: the Fed is monetizing government debt.
Comment know, this is just step one. "Monetizing the Gov'ts debt" is just the same as buying outstanding obligations. Flooding the public with CASH.
Apparently this (monetizing) was necessary because of a "liquidity crunch". However, given a slight change in termiinology: This could also be seen as a "LOSS OF CONFIDENCE" in the "Government's" (Quasi) Debt (in the first place)!...Oh My God!
In this loss of confidence, step 2 is the loss in confidence of the dollar itself. Then we're all toast, except for our country's stockpiles of weapons and ammo!
17 - The US Federal Reserve
If the world is a stage, these are key settings on the stage.
Read More...
President Woodrow Wilson signed the Federal Reserve Act on Dec. 23, 1913, creating a seven-member board of governors, including the Fed chairman, and 12 regional banks — a structure collectively known as the Federal Reserve System. The governors are appointed by the president and approved by Congress; the regional bank presidents are selected by leaders of their communities, particularly bankers.
Private banks controlled the flow of credit and thus interest rates in the late 19th and early 20th centuries, and farmers, the backbone of the populist movement, complained that the big Eastern banks often starved them of credit at critical moments. Populists called for direct access to credit, without the banks as intermediaries. That did not happen.
The Federal Reserve System was a compromise. The banks would remain the lenders to the public, but the Fed would control the supply of funds on which the banks depended to make loans. Injecting more money into the banking system put downward pressure on interest rates, while its opposite, restricting the supply of potential credit, pushed up rates. The regional banks were intended to help make the flow of credit even across the country.
Through various refinements over the years, this “open market” operation, as it was called, has been at the heart of the Fed’s power. The interest rate that results is called the federal funds rate. In turn, the interest that banks and other lenders charge for mortgages and for various forms of commercial and consumer credit fluctuate with the federal funds rate. As a supplement, to assure an even flow of available credit, commercial banks in various parts of the country can borrow directly from the Fed at the nearest regional bank, using the so-called discount window. The discount rate is linked to the federal funds rate.
The federal funds rate is set by the Fed’s Open Market Committee, composed of the chairman, currently Ben S. Bernanke, the six other governors, and five of the 12 regional bank presidents, on a rotating basis. The committee meets at Fed headquarters in Washington every six weeks or so.
The Fed’s chairman, currently Ben S. Bernanke and before him Alan Greenspan and Paul A. Volcker, dominates Open Market operations. Their main thrust has been to limit inflation, even at the risk of a recession — although they have cut rates when the nation seemed in danger of one, as the Bernanke Fed has recently done.
— Louis Uchitelle Oct. 12, 2007
Created 1913 after the big depression.
Fed Takes a $3 Trillion Gamble to Spur Lending: John M. Berry, Bloomberg 5 dec.2008
So far this year, the Fed has aggressively reduced its overnight lending rate target to only 1 percent, and it probably will trim it by another 50 basis points at a Dec. 15-16 Federal Open Market Committee meeting.
Balance Sheet
It has also pumped unprecedented amounts of liquidity into the banking system using loans and new auction techniques. And recently the central bank began providing credit directly to businesses and financial institutions by buying commercial paper and other assets.
As a result, the Fed's balance sheet has ballooned to $2.1 trillion from less than $900 billion a year ago. On Nov. 25, it said it would buy another $800 billion worth of asset-backed securities, expanding the balance sheet to almost $3 trillion.
purpose of central banking is to ensure sound money and safe banking
federal deposit insurance
Key function: the lender of last resort, provides cash to temporarily illiquid banks.
Walter Bagehot, warned us that there would be times when a central bank couldn't effectively distinguish between illiquidity and insolvency.
Federal Reserve
Committed
Spent up to Nov 08
Commercial Paper Funding Facility LLC
CPFF
1,800,000,000,000
270,879,000,000
Term Auction Facility
TAF
900,000,000,000
415,302,000,000
Other Assets MBS??? TALF partII?
601,963,000,000
601,963,000,000
Money Market Investor Funding Facility
MMIFF
540,000,000,000
0
Term Securities Lending Facility
TSLF
250,000,000,000
190,200,000,000
Term Asset Backed Securities Loan Facility
TALF
200,000,000,000
0
Other Credit Extensions (AIG)
122,800,000,000
122,800,000,000
Primary Credit Discount
92,600,000,000
92,600,000,000
ABCP Money Market Fund Liquidity Facility
AMLF
61,900,000,000
61,900,000,000
Primary Dealer and Others
PDCF
46,611,000,000
46,611,000,000
Net Portfolio Maiden Lane LLC(Bear Sterns)
28,800,000,000
26,900,000,000
Securities Lending Overnight
10,300,000,000
10,300,000,000
Secondary Credit
118,000,000
118,000,000
Total
4,655,092,000,000
1,839,573,000,000
percentage to grand total
59.00%
A close look at the Federal Reserve balance sheet tells us that Ben Bernanke eventually intends to devalue the U.S. dollar against gold. There has been a vast expansion of Fed credit, which has risen from $932 billion to $2.25 trillion in the last two and a half months. The Fed has bought nearly all toxic bank assets that were supposed to be purchased pursuant by the $700 billion Congressional bank bailout.
The Manipulation of Gold Prices. James Conrad 4 Dec Seekingalpha.com
By avoiding the use of monitored Congressional funds, the Fed has embarked on a secretive campaign to buy toxic assets.
The Federal Reserve has embarked on the biggest money printing surge in history, though the world economy has yet to feel its effect. To prevent newly printed dollars from causing immediate hyperinflation, these newly printed dollars have been temporarily sequestered into the banking industry’s reserves, rather than being released for general use. This was done in a number of creative ways.
First, the number of “reverse repurchase agreements” has been increased to $97 billion. A “repurchase agreement” is a non-recourse method by which the Fed increases the money supply by paying dollars for collateral. The collateral, in this case, are toxic defaulting mortgage bonds that banks want to be rid of. The cash enters the system and theoretically stimulates the economy because it supplies banks with money to make loans with.
A “reverse repurchase agreement” is the exact opposite. It is a method of reducing the money supply by selling bonds to the banks, and taking the cash back out of the system. In this case, the Fed gave banks cash for toxic defaulting mortgage bonds. Then, it took the same cash back by selling the banks new treasury bills just received from the U.S. Treasury. The Fed, in turn, bought these T-bills with the newly printed dollars. The banks, having gotten rid of toxic assets, were allowed to transfer private risk to the taxpayers. This process bolsters bank balance sheets by privatizing bank profits, and socializing bank losses.
At the same time, the U.S. Treasury has been very busy selling newly printed Treasury bills to anyone foolish enough to buy them. To a large extent, the fools reside overseas, but some reside inside this country, and the sale of these U.S. bonds has resulted in a substantial inflow of foreign reserves to the Treasury. Banks have also been offered favorable interest rates on both reserve and non-reserve deposits held at the Fed.
Federal Reserve
The Federal Reserve, through its power to raise and lower interest rates, exercises more influence over economic growth and the level of employment than any other government entity. That unusual role dates from the 1970s, when the executive branch and Congress pulled back from the use of fiscal tools — vast New Deal spending and targeted tax cuts — as a means of regulating prosperity.
The Federal Reserve, through its power to raise and lower interest rates, exercises more influence over economic growth and the level of employment than any other government entity. That unusual role dates from the 1970s, when the executive branch and Congress pulled back from the use of fiscal tools — vast New Deal spending and targeted tax cuts — as a means of regulating prosperity.
Read More...
President Woodrow Wilson signed the Federal Reserve Act on Dec. 23, 1913, creating a seven-member board of governors, including the Fed chairman, and 12 regional banks — a structure collectively known as the Federal Reserve System. The governors are appointed by the president and approved by Congress; the regional bank presidents are selected by leaders of their communities, particularly bankers.
Private banks controlled the flow of credit and thus interest rates in the late 19th and early 20th centuries, and farmers, the backbone of the populist movement, complained that the big Eastern banks often starved them of credit at critical moments. Populists called for direct access to credit, without the banks as intermediaries. That did not happen.
The Federal Reserve System was a compromise. The banks would remain the lenders to the public, but the Fed would control the supply of funds on which the banks depended to make loans. Injecting more money into the banking system put downward pressure on interest rates, while its opposite, restricting the supply of potential credit, pushed up rates. The regional banks were intended to help make the flow of credit even across the country.
Through various refinements over the years, this “open market” operation, as it was called, has been at the heart of the Fed’s power. The interest rate that results is called the federal funds rate. In turn, the interest that banks and other lenders charge for mortgages and for various forms of commercial and consumer credit fluctuate with the federal funds rate. As a supplement, to assure an even flow of available credit, commercial banks in various parts of the country can borrow directly from the Fed at the nearest regional bank, using the so-called discount window. The discount rate is linked to the federal funds rate.
The federal funds rate is set by the Fed’s Open Market Committee, composed of the chairman, currently Ben S. Bernanke, the six other governors, and five of the 12 regional bank presidents, on a rotating basis. The committee meets at Fed headquarters in Washington every six weeks or so.
The Fed’s chairman, currently Ben S. Bernanke and before him Alan Greenspan and Paul A. Volcker, dominates Open Market operations. Their main thrust has been to limit inflation, even at the risk of a recession — although they have cut rates when the nation seemed in danger of one, as the Bernanke Fed has recently done.
— Louis Uchitelle Oct. 12, 2007
Created 1913 after the big depression.
Fed Takes a $3 Trillion Gamble to Spur Lending: John M. Berry, Bloomberg 5 dec.2008
So far this year, the Fed has aggressively reduced its overnight lending rate target to only 1 percent, and it probably will trim it by another 50 basis points at a Dec. 15-16 Federal Open Market Committee meeting.
Balance Sheet
It has also pumped unprecedented amounts of liquidity into the banking system using loans and new auction techniques. And recently the central bank began providing credit directly to businesses and financial institutions by buying commercial paper and other assets.
As a result, the Fed's balance sheet has ballooned to $2.1 trillion from less than $900 billion a year ago. On Nov. 25, it said it would buy another $800 billion worth of asset-backed securities, expanding the balance sheet to almost $3 trillion.
purpose of central banking is to ensure sound money and safe banking
federal deposit insurance
Key function: the lender of last resort, provides cash to temporarily illiquid banks.
Walter Bagehot, warned us that there would be times when a central bank couldn't effectively distinguish between illiquidity and insolvency.
Federal Reserve
Committed
Spent up to Nov 08
Commercial Paper Funding Facility LLC
CPFF
1,800,000,000,000
270,879,000,000
Term Auction Facility
TAF
900,000,000,000
415,302,000,000
Other Assets MBS??? TALF partII?
601,963,000,000
601,963,000,000
Money Market Investor Funding Facility
MMIFF
540,000,000,000
0
Term Securities Lending Facility
TSLF
250,000,000,000
190,200,000,000
Term Asset Backed Securities Loan Facility
TALF
200,000,000,000
0
Other Credit Extensions (AIG)
122,800,000,000
122,800,000,000
Primary Credit Discount
92,600,000,000
92,600,000,000
ABCP Money Market Fund Liquidity Facility
AMLF
61,900,000,000
61,900,000,000
Primary Dealer and Others
PDCF
46,611,000,000
46,611,000,000
Net Portfolio Maiden Lane LLC(Bear Sterns)
28,800,000,000
26,900,000,000
Securities Lending Overnight
10,300,000,000
10,300,000,000
Secondary Credit
118,000,000
118,000,000
Total
4,655,092,000,000
1,839,573,000,000
percentage to grand total
59.00%
A close look at the Federal Reserve balance sheet tells us that Ben Bernanke eventually intends to devalue the U.S. dollar against gold. There has been a vast expansion of Fed credit, which has risen from $932 billion to $2.25 trillion in the last two and a half months. The Fed has bought nearly all toxic bank assets that were supposed to be purchased pursuant by the $700 billion Congressional bank bailout.
The Manipulation of Gold Prices. James Conrad 4 Dec Seekingalpha.com
By avoiding the use of monitored Congressional funds, the Fed has embarked on a secretive campaign to buy toxic assets.
The Federal Reserve has embarked on the biggest money printing surge in history, though the world economy has yet to feel its effect. To prevent newly printed dollars from causing immediate hyperinflation, these newly printed dollars have been temporarily sequestered into the banking industry’s reserves, rather than being released for general use. This was done in a number of creative ways.
First, the number of “reverse repurchase agreements” has been increased to $97 billion. A “repurchase agreement” is a non-recourse method by which the Fed increases the money supply by paying dollars for collateral. The collateral, in this case, are toxic defaulting mortgage bonds that banks want to be rid of. The cash enters the system and theoretically stimulates the economy because it supplies banks with money to make loans with.
A “reverse repurchase agreement” is the exact opposite. It is a method of reducing the money supply by selling bonds to the banks, and taking the cash back out of the system. In this case, the Fed gave banks cash for toxic defaulting mortgage bonds. Then, it took the same cash back by selling the banks new treasury bills just received from the U.S. Treasury. The Fed, in turn, bought these T-bills with the newly printed dollars. The banks, having gotten rid of toxic assets, were allowed to transfer private risk to the taxpayers. This process bolsters bank balance sheets by privatizing bank profits, and socializing bank losses.
At the same time, the U.S. Treasury has been very busy selling newly printed Treasury bills to anyone foolish enough to buy them. To a large extent, the fools reside overseas, but some reside inside this country, and the sale of these U.S. bonds has resulted in a substantial inflow of foreign reserves to the Treasury. Banks have also been offered favorable interest rates on both reserve and non-reserve deposits held at the Fed.
Friday, February 27, 2009
16 - Glen Stevens/Australia
From the hawkish “boy from OZ” to the pioneer of central banks rate cut.
Glenn Stevens (born 23 January 1958) Governor of the Reserve Bank of Australia since 18 September 2006. He is the first Central Bank Governor in the world to make a huge interest rate cut during the September – October turmoil. (i.e. the 100 point cuts on 2 October 2008.)
15 - Masaaki Shirakawa/Japan
“expresses its strong support” for the October coordinate rate cuts.
Masaaki Shirakawa (白川方明,born September 27, 1949) is Governor of the Bank of Japan.
With the official interest rate at 0.5% but inflation at 2%. The real interest rate in Japan is -1.5%. Beside express support, not much else Shirakawa can do for his counterparts.
14 - Medvedev & Putin/Russia
President Medvedev, and? of course, Prime Minister PutinDAVOS, Switzerland (CNN) 28 January, 2009, during keynote speeches at the World Economic Forum.
Putin telling delegates that the crisis constituted a "perfect storm."
While economists and analysts could -- and should -- have predicted the crisis, Putin said, instead it had "come unexpectedly, just as winter comes unexpectedly to Russia every year."
13 - Hu Jin Tao/President of China
“Socialism is good.” Knew this since he was born.
Hu Jintao (胡锦涛born 21 December 1942) is currently the Paramount Leader of the People's Republic of China,
12 - José Manuel Barroso/ EC President
“There is no national road out of this crisis. We will swim or we will sink together."
11 - Jean-Claude Trichet/ EU President
“2007 Person of the Year” by the Financial Times. Crusader against inflation till Sept. 2008.Jean-Claude Trichet (born 20 December 1942) current president of the European Central Bank since 2003.
Up till August 2008, Trichet's No.1 task as president of the ECB is supposed to be delivering "price stability" to the 320 million citizens of the Eurozone
10 - Geir Hilmar Haarde, PM of Iceland
Vowed to catch more fish but less banking for future Iceland.
(born 8 April 1951) is Prime Minister of Iceland who has the dubious honor to received the title as the most developed country in the world by UN’s Human development Index in 2007 (US was ranked 12th) and announced the country gone bankrupt the next year.
Thursday, February 26, 2009
9 - Angela Merkel
Angela Merkel (born 17 July 1954), is the Chancellor of Germany. The new Iron Lady. One of her quote: “The question is not whether we are able to change but whether we are changing fast enough.” Surely the German policy maker changed very fast in October 2008.
8 - Nicolas Sarkozy
“Laisser faire is finished.” Declared by Sarkozy on 25 September 2008.
Nicolas Sarkozyborn on 28 January 1955, is the President of France and ex officio Co-Prince of Andorra. He assumed office on 16 May 2007.
Nicolas Sarkozyborn on 28 January 1955, is the President of France and ex officio Co-Prince of Andorra. He assumed office on 16 May 2007.
Nicholas Sarkozy made an important speech on 25 September 2008. He said:
The idea of an all-powerful market without any rules and any political intervention is mad. Self-regulation is finished. Laisser faire is finished. The all-powerful market that is always right is finished.
However, he also emphsised: The crisis is not a crisis of capitalism. It is the crisis of a system that is far from the values of capitalism and has betrayed capitalism. Capitalism must be refounded on the ethic of effort, hard work and fair rewards. We have to have a new balance between the state and the market.
7 - James Gordon Brown
wants a “new financial architecture for the global age”
James Gordon Brown (born 20 February 1951) is the Prime Minister of the United Kingdom of Great Britain and Northern Ireland. Prior to this he served as the Chancellor of the Exchequer under Tony Blair from 1997 to 2007.
6 - Barack Hussein Obama
“True genius of America is that it can change.” – Barack Obama, in his election victory speech.
“Tonight we proved once more that the true strength of our nation comes not from our the might of our arms or the scale of our wealth, but from the enduring power of our ideals: democracy, liberty, opportunity, and unyielding hope.”
For the first time since 1932, a U.S. presidential election was taking place in the midst of a genuine financial crisis.
5 - Timothy Franz Geithner
the Paulson successor, the man who will take the leading role in our next episode.
Timothy F. Geithner, New York Federal Reserve Bank President Nov 2003- Jan 2008.
Geithner, 47, born August 18, 1961 Chris Rupkey, economist at Bank of Tokyo-Mitsubishi in New York. He called Geithner a "crisis manager par excellence“
Treasury Secretary: Timothy Geithner/Time.com, By FRANCES ROMERO
He was named President and CEO of the New York Federal Reserve on November 20, 2003. As President he oversees the Reserve Bank as it monitors banks in New York, New Jersey, and Fairfield County in Connecticut, extends credit to banks, and conducts foreign exchange market intervention.
•Was directly involved in the move that allowed JP Morgan Chase to acquire Bear Stearns with $29 million provided by the government earlier this year. Also worked as part of the deal that saved AIG from failing.
•Would not grant Lehman Brothers the right to become a bank-holding company — a status given to both Morgan Stanley and Goldman Sachs just days after Lehman filed for bankruptcy.
4 - Alan Greenspan
...convinced deregulation & innovation in financial markets saved America
Full time Fed Chairman, Part time cheer leader of team deregulation & innovation.
Alan Greenspan (born March 6, 1926 in New York City) ex Fed Chairman 1987 - 2006
"Because of increased access to real-time information and, more arguably, extensive deregulation and innovation in financial and product markets, economic imbalances are more likely to be readily contained," 2002 April.
Greenspan convinced Congress that financial derivatives didn't need to be regulated.
Greenspan's criticisms of President Bush include his refusal to veto spending bills, sending the country into increasingly deep deficits, and for "putting political imperatives ahead of sound economic policies".
But perhaps Greenspan's most important contribution has been as the policymaker who, through the power of his office, the force of his intellect and the cunning of his behind-the-scenes maneuvering, engineered the wholesale deregulation of the U.S. banking and financial system. In this respect, his most enduring legacy is an American economy that is not only more prone to assets bubbles, corporate scandal and financial crises, but robust enough to absorb such shocks while continuing to deliver long-term economic growth. By Steven PearlsteinFriday, January 20, 2006.
To be fair, Mr Greenspan played a dual role in the events leading to the current economic turmoil.
On one hand, his faults played a pivotal role in 2008 financial down fall of US economics. On the other hand, his ingenious approach in dealing with the economy during his tenure (a rather turbulent period) enabled us to see the longest post war expansion of the US economy. He used to be able to cast those magic spell over lawmakers in provide a more financial free markt.
It is, thus, all the more important to recognize that twenty-first century financial regulation is going to increasingly have to rely on private counterparty surveillance to achieve safety and soundness. There is no credible way to envision most government financial regulation being other than oversight of process. As the complexity of financial intermediation on a worldwide scale continues to increase, the conventional regulatory examination process will become progressively obsolescent--at least for the more complex banking systems. (emphasis added-w.e.)
3 - George Walker Bush
The economic events coordinator, speaker
(born July 6, 1946) is the President of the United States from January 20, 2001 – January 20, 2009.
(born July 6, 1946) is the President of the United States from January 20, 2001 – January 20, 2009.
Also the commander in Chief of the “visible” wars such as Iraq and Afganistan.
The speeches/pleas Mr President made to his fellow countryman/congressman during the Sept/Oct chaos must be equal to, if not great than, the combined number of speeches/pleas his made during his entire presidency. A remarkable effort! Considering…
2 - Ben Shalom Bernanke
The Chairman who succeeded Greenspan.
(born December 13, 1953) Chairman of the Board of Governors of the United States Federal ReserveBernanke succeeded Alan Greenspan on February 1, 2006 He received a PhD in economics from the Massachusetts Institute of Technology in 1979.
His role is of equal importance as Paulson’s. Thankfully, both men lost their hair well before all this happened. At least one less sign available to be observed as both men are under tremendous pressure to fix the economy. Dr. Bernanke is on a hopeless task, and his theories, borne out his academic studies of the Great Depression, means that we will get a new sort of Great Depression. There is no easy solution; it is merely a situation where we choose which poison we want to take while the deleveraging goes on. My guess is that we see some combination of malaise plus inflation.
Bernanke got a new nick name Bernie Mac after Fed’s bailout of Freddie Mac and Fannie Mae.
But investors doubt that Bernanke will ever be the true inflation fighter and currency protector that his job requires.
1 - Henry Merritt Paulson
Paulson’s comment: “I believe in markets. I also believe that there is a role for government. Raw capitalism is a dead end. I’ve seen it.”
Paulson played a leading role in the global fight against the Credit Freeze. Perhaps the toughest job on the planet, Paulson was officially appointed as Treasury Secretary July 10, 2006.
(born March 28, 1946) is the United States Treasury Secretary and member of the nternational Monetary Fund Board of Governors. He previously served as the Chairman and Chief Executive Officer of Goldman Sachs.
Not only is King Henry the chief salesman for Reaganomics and the archconservative Bush administration, he's worth $800 million -PAUL B. FARRELL.
Marketwatch 3/13/07: Paulson also said the fallout in subprime mortgages is "going to be painful to some lenders, but it is largely contained."
Reuters 4/20/07: "I don't see (subprime mortgage market troubles) imposing a serious problem. I think it's going to be largely contained."
Bloomberg 5/22/07: Paulson, also speaking to CNBC, said the housing slump was ``largely contained'' and that market's correction was mostly ``behind us.''
Bloomberg 6/20/07: Subprime fallout ``will not affect the economy overall.''
Forbes 7/27/07: Appearing on CNBC with other members of the Bush administration's economic team, he again said mortgage industry problems would be 'largely contained.'
Boston.com 8/1/07: Paulson added that he did not see anything that caused him to reconsider his view that the economic damage from the housing correction was "largely contained.
Many in the global press are calling him "King Henry." Henry's now the biggest power-player in the world. If he pulls this hat trick off, history will put him on par with J. Pierpont Morgan, who rescued the U.S. government twice, from the 1895 depression and the 1907 financial crisis. No wonder he's now the de facto president as well as CEO and "Chief Securities Analyst" for the "New America Corporation."
Part Three/In the spot light - In the leading role
A leader or a man of action in a crisis almost always acts subconsciously and then thinks of the reasons for his action. Jawaharlal Nehru
Pity the leader caught between unloving critics and uncritical lovers. John Gardner
In the leading role
As I mentioned in the preface, I am not here to judge who is the villain or hero. Let’s just say that no one is perfect. For those people below, their imperfection is more related to the current crisis than most of the other people involved.
"The world is a stage, each must play a part". Shakespeare.
Rarely, so many the most prominent people around the world played their role on the same stage during the same event.
Pity the leader caught between unloving critics and uncritical lovers. John Gardner
In the leading role
As I mentioned in the preface, I am not here to judge who is the villain or hero. Let’s just say that no one is perfect. For those people below, their imperfection is more related to the current crisis than most of the other people involved.
"The world is a stage, each must play a part". Shakespeare.
Rarely, so many the most prominent people around the world played their role on the same stage during the same event.
11- 2001: The dot com bubble burst
March 2000 – Oct 2002: 2001 recession, 2002 slow recovery
2003 to 2007 schronized global growth at a fast pace.
From the 2000 peak to 2002 trough, S&P 500 profits fell 84%. 2003 started to bounce, 15% in 03, 19% in 04 and 29% in 06.
From 1991 to 2000, the U.S. experienced 37 quarters of economic expansion, the longest period of expansion on record.
Main article: List of recessions in the United States
According to economists, since 1854, the U.S.A. has encountered 32 cycles of expansions and contractions, with an average of 17 months of contraction and 38 months of expansion. However, since 1980 there have been only eight periods of negative economic growth over one fiscal quarter or more, and three periods considered recessions:
January-July 1980 and July 1981-November 1982: 2 years total
July 1990-March 1991: 8 months
November 2001-November 2002: 12 months
2000 Fed starts to cut interest rate.
2003 to 2007 schronized global growth at a fast pace.
From the 2000 peak to 2002 trough, S&P 500 profits fell 84%. 2003 started to bounce, 15% in 03, 19% in 04 and 29% in 06.
From 1991 to 2000, the U.S. experienced 37 quarters of economic expansion, the longest period of expansion on record.
Main article: List of recessions in the United States
According to economists, since 1854, the U.S.A. has encountered 32 cycles of expansions and contractions, with an average of 17 months of contraction and 38 months of expansion. However, since 1980 there have been only eight periods of negative economic growth over one fiscal quarter or more, and three periods considered recessions:
January-July 1980 and July 1981-November 1982: 2 years total
July 1990-March 1991: 8 months
November 2001-November 2002: 12 months
2000 Fed starts to cut interest rate.
10- 1990s: Japan’s lost decade
Japanese Asset Bubble: 1986 – 1990, The bubble. 1990 -2003, The burst.
Nikki: Peak: 9 Dec 1989: 38957.44
Bottom: April 2003: 7603.76. A 80% decline!
The U.S. Financial Crisis:Lessons From Japan - Dick K. NantoSpecialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division
Summary
Japan’s five bank bailout packages in the late 1990s may hold some lessons for the United States. Most of the packages were administered by the Deposit Insurance Corporation of Japan (DICJ). The packages had an announced value of $495 billion.
The DICJ reports that it provided $399 billion to Japan’s troubled financial institutions of which it has recovered $195 billion. Overcoming the crisis in Japan’s banks took a combination of capital injections, new laws and regulations, stronger oversight, a reorganization of the banking sector, moderate economic recovery, and several years of banks working off their non-performing loans. This report will be updated as
circumstances warrant.
When the U.S. Treasury planned the $700 billion bailout package (Emergency Economic Stabilization Act of 2008, H.R. 3997) to address the U.S. financial crisis, it reportedly examined the experience of Japan as it grappled with its banking crisis in the 1990s.1 This report reviews the major actions by the Japanese government in dealing with its crisis and highlights some of the lessons learned from their experience.
Like the current U.S. financial crisis, Japan’s began with stock market and real estate bubbles. During the latter half of the 1980s, Japan’s monetary authorities flooded the market with liquidity (money) in order to enable businesses to cope with the rising value of the yen. Businesses did invest in new capital equipment to become more competitive in international markets, but the excess liquidity also found its way into speculation in
Japan’s stock market, in real estate ventures, and in foreign investments. At that time, the market value of both land and equities was rising so fast that investors and speculators could hardly miss.
Japan’s Nikkei stock market average peaked in 1989 at 40,000 and dropped by 50% in one year and more than two-thirds to about 12,000 by August 2001. Japan’s banks are allowed to hold equities as part of their capital base. The value of the unrealized capital gains on such stock holdings dropped from $355 billion in 1989 to $42 billion in 2001. This drastically reduced key capital reserves for many banks. Also, by 2000, commercial land values in the six major metropolitan areas had fallen by 80% from their peak level in 1991. Residential and industrial land values also had fallen by nearly 20%.2
The Japanese experience of a 10-year economic winter is regarded as the template for how not to respond to the kind of conditions the global economy now confronts. The Japanese authorities were slow to respond and overly cautious when they did.
Problem: After a spectacular 1980s boom, Japan's real estate and stock markets crashed, throwing the economy into a prolonged malaise.Outcome: Early denial of the problem by the Japanese government taught policymakers elsewhere the value of responding quickly and decisively
In 2008: For Japanese equity investors, it has not just been a lost decade, it has been a lost quarter-century; the Nikkei 225 average touched a 26-year low in Nov 08.
"The experience of Japan in the 1990s was that indeed government spending, while it may not produce a permanent cure, can greatly alleviate the pressures on the economy," Paul Krugman said.
Nikki: Peak: 9 Dec 1989: 38957.44
Bottom: April 2003: 7603.76. A 80% decline!
The U.S. Financial Crisis:Lessons From Japan - Dick K. NantoSpecialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division
Summary
Japan’s five bank bailout packages in the late 1990s may hold some lessons for the United States. Most of the packages were administered by the Deposit Insurance Corporation of Japan (DICJ). The packages had an announced value of $495 billion.
The DICJ reports that it provided $399 billion to Japan’s troubled financial institutions of which it has recovered $195 billion. Overcoming the crisis in Japan’s banks took a combination of capital injections, new laws and regulations, stronger oversight, a reorganization of the banking sector, moderate economic recovery, and several years of banks working off their non-performing loans. This report will be updated as
circumstances warrant.
When the U.S. Treasury planned the $700 billion bailout package (Emergency Economic Stabilization Act of 2008, H.R. 3997) to address the U.S. financial crisis, it reportedly examined the experience of Japan as it grappled with its banking crisis in the 1990s.1 This report reviews the major actions by the Japanese government in dealing with its crisis and highlights some of the lessons learned from their experience.
Like the current U.S. financial crisis, Japan’s began with stock market and real estate bubbles. During the latter half of the 1980s, Japan’s monetary authorities flooded the market with liquidity (money) in order to enable businesses to cope with the rising value of the yen. Businesses did invest in new capital equipment to become more competitive in international markets, but the excess liquidity also found its way into speculation in
Japan’s stock market, in real estate ventures, and in foreign investments. At that time, the market value of both land and equities was rising so fast that investors and speculators could hardly miss.
Japan’s Nikkei stock market average peaked in 1989 at 40,000 and dropped by 50% in one year and more than two-thirds to about 12,000 by August 2001. Japan’s banks are allowed to hold equities as part of their capital base. The value of the unrealized capital gains on such stock holdings dropped from $355 billion in 1989 to $42 billion in 2001. This drastically reduced key capital reserves for many banks. Also, by 2000, commercial land values in the six major metropolitan areas had fallen by 80% from their peak level in 1991. Residential and industrial land values also had fallen by nearly 20%.2
The Japanese experience of a 10-year economic winter is regarded as the template for how not to respond to the kind of conditions the global economy now confronts. The Japanese authorities were slow to respond and overly cautious when they did.
Problem: After a spectacular 1980s boom, Japan's real estate and stock markets crashed, throwing the economy into a prolonged malaise.Outcome: Early denial of the problem by the Japanese government taught policymakers elsewhere the value of responding quickly and decisively
In 2008: For Japanese equity investors, it has not just been a lost decade, it has been a lost quarter-century; the Nikkei 225 average touched a 26-year low in Nov 08.
"The experience of Japan in the 1990s was that indeed government spending, while it may not produce a permanent cure, can greatly alleviate the pressures on the economy," Paul Krugman said.
9 – 1998: The Russia default & LTCM
The Russian financial crisis (also called "Ruble crisis") hit Russia on 17 August 1998.
It was exacerbated by the Asian financial crisis, which started in July 1997. Given the ensuing decline in world commodity prices, countries heavily dependent on the export of raw materials, such as oil, were among those most severely hit. (Petroleum, natural gas, metals, and timber accounted for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices. Oil was also a major source of government tax revenue.[1]) The sharp decline in the price of oil had severe consequences for Russia. However, the primary cause of the Russian Financial Crisis was not the fall of oil prices directly, but the result of non-payment of taxes by the energy and manufacturing industries.
On August 17, 1998, the Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in substance, that: (i) the ruble/dollar trading band would be widened from 5.3-7.1 RUR/USD to 6.0-9.5 RUR/USD; (ii) Russia's ruble-denominated debt would be restructured in a manner to be announced at a later date; and, to prevent mass Russian bank default, (iii) a temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts[6]. At the same time, in addition to widening the currency band, the authorities also announced that they intended to allow the RUR/USD rate to move more freely within the wider band.
At the time, the Moscow Interbank Currency Exchange (or "MICEX") set a daily "official" exchange rate through a series of iterative auctions based on written bids submitted by buyers and sellers. When the buy and sell prices matched this "fixed" or "settled" the official MICEX exchange rate, which would then be published by Reuters. The MICEX rate was (and is) commonly used by banks and currency dealers worldwide as the reference exchange rate for transactions involving the Russian ruble and foreign currencies.
From August 17 to August 25, the ruble steadily depreciated on the MICEX, moving from 6.43 to 7.86 RUR/USD. On August 26, the Central Bank terminated ruble-dollar trading on the MICEX, and the MICEX did not fix a ruble-dollar rate that day.
LTCM:
LTCM was founded in 1994 by John Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Board of directors members included Myron Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences, the Nobel Prize in Economics[2] and it is identified with the Nobel Prizes, although it is not one of the five Nobel Prizes (in Physics, Chemistry, Physiology or Medicine, Literature, and Peace) officially named The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.
As a Big Swinging Dick hedge fund with the most stellar partners and a huge capital base, LTCM was able to convince banks to lend them money at rates that were not available to lesser mortals (including investment banks like Salomon Brothers). LTCM used this credit to leverage their capital base by a factor of twenty to thirty times.
Initially enormously successful with annualized returns of over 40% (after fees) in its first years, in 1998 just a year after the award, The company experienced a flight-to-liquidity. it lost $4.6 billion in less than four months following the Russian financial crisis and became a prominent example of the risk potential in the hedge fund industry. The fund folded in early 2000.
in May and June 1998 returns from the fund were -6.42% and -10.14% respectively, reducing LTCM's capital by $461 million. This was further aggravated by the exit of Salomon Brothers from the arbitrage business in July 1998. Such losses were accentuated through the Russian financial crises in August and September 1998, when the Russian Government defaulted on their government bonds. Panicked investors sold Japanese and European bonds to buy U.S. treasury bonds. The profits that were supposed to occur as the value of these bonds converged became huge losses as the value of the bonds diverged. By the end of August, the fund had lost $1.85 billion in capital.
the Federal Reserve Bank of New York organized a bailout of $3.625 billion by the major creditors to avoid a wider collapse in the financial markets. The contributions from the various institutions were as follows:
$300 million: Bankers Trust, Barclays, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Merrill Lynch, J.P.Morgan, Morgan Stanley, Salomon Smith Barney, UBS
$125 million: Société Générale
$100 million: Lehman Brothers, Paribas
Bear Stearns declined to participate.
In return, the participating banks got a 90% share in the fund and a promise that a supervisory board would be established.
The total losses were found to be $4.6 billion. The losses in the major investment categories were (ordered by magnitude):
$1.6 bn in interest swaps
$1.3 bn in equity volatility
$430 mn in Russia and other emerging markets
$371 mn in directional trades in developed countries
$215 mn in yield curve arbitrage
$203 mn in S&P 500 stocks
$100 mn in junk bond arbitrage
no substantial losses in merger arbitrage
This table makes it clear that the last two items, interest swaps and equity volatility bets, account for the majority of the losses. LTCM's losses where large for two reasons:
LTCM used large amounts of leverage. For every dollar of assets in the fund they borrowed twenty to thirty dollars to place their trading bets. In many cases the loans made to LTCM where the equivalent of signature loans. There were not backed by securities and there were no margin calls when the value of LTCM's assets dropped. Leverage greatly magnified LTCM's profits when they bet correctly. It also greatly magnified their losses when the market turned against them. Although LTCM's returns were impressive when they did well, their risk adjusted returns were not nearly as good.
Low liquidity. Or to put it simply, there were few buyers when the market turned against LTCM.
Interest rate swaps are contracts between two parties. They do not trade on an open market the way stocks, bonds or exchange traded options do. The options contracts that LTCM traded in their volatility bets were huge customized option contracts:
The investors that had money in LTCM got ten cents on their invested dollar. The partners were largely wiped out. Once LTCM's market positions were unwound the rescue consortium made money on their investment.after the bailout by the other investors, the panic abated, and the positions formerly held by LTCM were eventually liquidated at a small profit to the bailers.
Ian Kaplan - October, 2000 book review on “when genius failed: The Rise and Fall of Long-Term Capital Management” by Roger Lowenstein
When markets are stable and no events like the "Asian melt-down" or the Russian bond default perturb them, the assumptions above tend to be true. In fact, during the first three years of LTCM's history, markets were very placid.
Efficient markets show linear behavior that can be described with calculus and statistics. Academics like this because it leads to elegant results which make good journal articles, with nice equations. There is, in fact, some reason to believe that markets are efficient. But there should always be a caveat: markets are efficient, on average, over a long period of time. Unfortunately for those who actually trade in the market, short term effects can be anything but "efficient" and perfect. Unlike physics, where theory is eventually tested against experimental results, much of economics seems almost willfully ignorant of the way the market behaves.
Those who are active in the market, like George Soros, tend to discount academic theory. Anyone who hears news reports about the stock market will realize that rather than being perfectly efficient, markets are not always placid, but sometimes act like a manic depressive, gripped by wild euphoria one moment and crashes the next. A whole language has grown up to describe market "mood", complete with mascots: the bull and the bear.
Markets exhibit avalanche events: a seemingly small trigger can produce a massive wave of change in the market. In the case of LTCM, the avalanche was triggered by the Russian bond default. LTCM was not the only trading firm to lose large amounts of money. Virtually every investment bank lost money when interest rate spreads widened unexpectedly.
Some industry officials said that Federal Reserve Bank of New York involvement in the rescue, however benign, would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf in the event of trouble. Federal Reserve Bank of New York actions raised concerns among some market observers that it could create moral hazard.
Bailout of Long-Term Capital: A Bad Precedent? TYLER COWEN Dec 26 nytimes.com Long-Term Capital was advised by finance quants, or quantitative analysts, who made a number of unsound, esoteric bets, including investments in interest rate derivatives. When Russia’s inability to pay its debts roiled global markets, the fund, saddled with high-leverage and off-balance-sheet obligations, was near collapse.
Because Long-Term Capital owed large sums to banks and other financial institutions, the Federal Reserve Bank of New York organized a consortium of companies to buy it out and cover the debts. Alan Greenspan, then the Fed chairman, eased monetary policy to restart capital markets, which were starting to freeze up. Long-Term Capital’s shareholders were wiped out, but none of the creditors took losses.
The side effect: At the time, it may have seemed that regulators did the right thing. The bailout did not require upfront money from the government, and the world avoided an even bigger financial crisis. Today, however, that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.
It was exacerbated by the Asian financial crisis, which started in July 1997. Given the ensuing decline in world commodity prices, countries heavily dependent on the export of raw materials, such as oil, were among those most severely hit. (Petroleum, natural gas, metals, and timber accounted for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices. Oil was also a major source of government tax revenue.[1]) The sharp decline in the price of oil had severe consequences for Russia. However, the primary cause of the Russian Financial Crisis was not the fall of oil prices directly, but the result of non-payment of taxes by the energy and manufacturing industries.
On August 17, 1998, the Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in substance, that: (i) the ruble/dollar trading band would be widened from 5.3-7.1 RUR/USD to 6.0-9.5 RUR/USD; (ii) Russia's ruble-denominated debt would be restructured in a manner to be announced at a later date; and, to prevent mass Russian bank default, (iii) a temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts[6]. At the same time, in addition to widening the currency band, the authorities also announced that they intended to allow the RUR/USD rate to move more freely within the wider band.
At the time, the Moscow Interbank Currency Exchange (or "MICEX") set a daily "official" exchange rate through a series of iterative auctions based on written bids submitted by buyers and sellers. When the buy and sell prices matched this "fixed" or "settled" the official MICEX exchange rate, which would then be published by Reuters. The MICEX rate was (and is) commonly used by banks and currency dealers worldwide as the reference exchange rate for transactions involving the Russian ruble and foreign currencies.
From August 17 to August 25, the ruble steadily depreciated on the MICEX, moving from 6.43 to 7.86 RUR/USD. On August 26, the Central Bank terminated ruble-dollar trading on the MICEX, and the MICEX did not fix a ruble-dollar rate that day.
LTCM:
LTCM was founded in 1994 by John Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Board of directors members included Myron Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences, the Nobel Prize in Economics[2] and it is identified with the Nobel Prizes, although it is not one of the five Nobel Prizes (in Physics, Chemistry, Physiology or Medicine, Literature, and Peace) officially named The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.
As a Big Swinging Dick hedge fund with the most stellar partners and a huge capital base, LTCM was able to convince banks to lend them money at rates that were not available to lesser mortals (including investment banks like Salomon Brothers). LTCM used this credit to leverage their capital base by a factor of twenty to thirty times.
Initially enormously successful with annualized returns of over 40% (after fees) in its first years, in 1998 just a year after the award, The company experienced a flight-to-liquidity. it lost $4.6 billion in less than four months following the Russian financial crisis and became a prominent example of the risk potential in the hedge fund industry. The fund folded in early 2000.
in May and June 1998 returns from the fund were -6.42% and -10.14% respectively, reducing LTCM's capital by $461 million. This was further aggravated by the exit of Salomon Brothers from the arbitrage business in July 1998. Such losses were accentuated through the Russian financial crises in August and September 1998, when the Russian Government defaulted on their government bonds. Panicked investors sold Japanese and European bonds to buy U.S. treasury bonds. The profits that were supposed to occur as the value of these bonds converged became huge losses as the value of the bonds diverged. By the end of August, the fund had lost $1.85 billion in capital.
the Federal Reserve Bank of New York organized a bailout of $3.625 billion by the major creditors to avoid a wider collapse in the financial markets. The contributions from the various institutions were as follows:
$300 million: Bankers Trust, Barclays, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Merrill Lynch, J.P.Morgan, Morgan Stanley, Salomon Smith Barney, UBS
$125 million: Société Générale
$100 million: Lehman Brothers, Paribas
Bear Stearns declined to participate.
In return, the participating banks got a 90% share in the fund and a promise that a supervisory board would be established.
The total losses were found to be $4.6 billion. The losses in the major investment categories were (ordered by magnitude):
$1.6 bn in interest swaps
$1.3 bn in equity volatility
$430 mn in Russia and other emerging markets
$371 mn in directional trades in developed countries
$215 mn in yield curve arbitrage
$203 mn in S&P 500 stocks
$100 mn in junk bond arbitrage
no substantial losses in merger arbitrage
This table makes it clear that the last two items, interest swaps and equity volatility bets, account for the majority of the losses. LTCM's losses where large for two reasons:
LTCM used large amounts of leverage. For every dollar of assets in the fund they borrowed twenty to thirty dollars to place their trading bets. In many cases the loans made to LTCM where the equivalent of signature loans. There were not backed by securities and there were no margin calls when the value of LTCM's assets dropped. Leverage greatly magnified LTCM's profits when they bet correctly. It also greatly magnified their losses when the market turned against them. Although LTCM's returns were impressive when they did well, their risk adjusted returns were not nearly as good.
Low liquidity. Or to put it simply, there were few buyers when the market turned against LTCM.
Interest rate swaps are contracts between two parties. They do not trade on an open market the way stocks, bonds or exchange traded options do. The options contracts that LTCM traded in their volatility bets were huge customized option contracts:
The investors that had money in LTCM got ten cents on their invested dollar. The partners were largely wiped out. Once LTCM's market positions were unwound the rescue consortium made money on their investment.after the bailout by the other investors, the panic abated, and the positions formerly held by LTCM were eventually liquidated at a small profit to the bailers.
Ian Kaplan - October, 2000 book review on “when genius failed: The Rise and Fall of Long-Term Capital Management” by Roger Lowenstein
When markets are stable and no events like the "Asian melt-down" or the Russian bond default perturb them, the assumptions above tend to be true. In fact, during the first three years of LTCM's history, markets were very placid.
Efficient markets show linear behavior that can be described with calculus and statistics. Academics like this because it leads to elegant results which make good journal articles, with nice equations. There is, in fact, some reason to believe that markets are efficient. But there should always be a caveat: markets are efficient, on average, over a long period of time. Unfortunately for those who actually trade in the market, short term effects can be anything but "efficient" and perfect. Unlike physics, where theory is eventually tested against experimental results, much of economics seems almost willfully ignorant of the way the market behaves.
Those who are active in the market, like George Soros, tend to discount academic theory. Anyone who hears news reports about the stock market will realize that rather than being perfectly efficient, markets are not always placid, but sometimes act like a manic depressive, gripped by wild euphoria one moment and crashes the next. A whole language has grown up to describe market "mood", complete with mascots: the bull and the bear.
Markets exhibit avalanche events: a seemingly small trigger can produce a massive wave of change in the market. In the case of LTCM, the avalanche was triggered by the Russian bond default. LTCM was not the only trading firm to lose large amounts of money. Virtually every investment bank lost money when interest rate spreads widened unexpectedly.
Some industry officials said that Federal Reserve Bank of New York involvement in the rescue, however benign, would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf in the event of trouble. Federal Reserve Bank of New York actions raised concerns among some market observers that it could create moral hazard.
Bailout of Long-Term Capital: A Bad Precedent? TYLER COWEN Dec 26 nytimes.com Long-Term Capital was advised by finance quants, or quantitative analysts, who made a number of unsound, esoteric bets, including investments in interest rate derivatives. When Russia’s inability to pay its debts roiled global markets, the fund, saddled with high-leverage and off-balance-sheet obligations, was near collapse.
Because Long-Term Capital owed large sums to banks and other financial institutions, the Federal Reserve Bank of New York organized a consortium of companies to buy it out and cover the debts. Alan Greenspan, then the Fed chairman, eased monetary policy to restart capital markets, which were starting to freeze up. Long-Term Capital’s shareholders were wiped out, but none of the creditors took losses.
The side effect: At the time, it may have seemed that regulators did the right thing. The bailout did not require upfront money from the government, and the world avoided an even bigger financial crisis. Today, however, that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.
8 – 1997: Asia financial crisis
Problem: The collapse of the Thai baht in 1997 sparked a crisis that spread across East Asia. The International Monetary Fund stepped in to help, but its draconian terms brought widespread criticism.
Outcome: A still-unresolved debate abouthow currency crises should be managed.
It was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown (financial contagion). It is also commonly referred to as the IMF crisis.
The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.[1]
Interestingly, Although the two events were unrelated, the collapse of the Thai baht on July 2, 1997, came only 24 hours after the United Kingdom handed over sovereignty of Hong Kong to the People's Republic of China. In October 1997, the Hong Kong dollar, which had been pegged at 7.8 to the U.S. dollar since 1983, came under speculative pressure because Hong Kong's inflation rate had been significantly higher than the U.S.'s for years. Monetary authorities spent more than US$1 billion to defend the local currency.
Stock markets became more and more volatile; between 20 October and 23 October the Hang Seng Index dropped 23%. The Hong Kong Monetary Authority then promised to protect the currency. On 15 August 1998, it raised overnight interest rates from 8% to 23%, and at one point to 500%. The HKMA had recognized that speculators were taking advantage of the city's unique currency-board system, in which overnight rates automatically increase in proportion to large net sales of the local currency. The rate hike, however, increased downward pressure on the stock market, allowing speculators to profit by short selling shares. The HKMA started buying component shares of the Hang Seng Index in mid-August.
The HKMA and Donald Tsang, then the Financial Secretary, declared war on speculators. The Government ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies,[20] and became the largest shareholder of some of those companies (e.g. the government owned 10% of HSBC) at the end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. The Government started selling those shares in 2001, making a profit of about HK$30 billion (US$4 billion).
The IMF created a series of bailouts ("rescue") packages for the most affected economies to enable affected nations to avoid default, tying the packages to reforms that were intended to make the restored Asian currency, banking, and financial systems as much like those of the United States and Europe as possible.
IMF intervention has been roundly criticized. The role of the International Monetary Fund was so controversial during the crisis that many locals called the financial crisis the "IMF crisis".[15] To begin with, many commentators in retrospect criticized the IMF for encouraging the developing economies of Asia down the path of "fast track capitalism", meaning liberalization of the financial sector (elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.[14]
IMF's Role in the Asian Financial Crisisby Walden Bello
The swift evaporation of the Asian economic "miracle" probably ranks second only to the unraveling of Soviet socialism as the greatest surprise of the last half-century. All at once, convention has been turned on its head as South Korea, Thailand and Indonesia line up for multibillion-dollar bailouts from the International Monetary Fund (IMF). Many of the same institutions and people who recently celebrated the Asian "tigers" as the engine of world growth into the 21st century now speak of them as a source of financial contagion, or, as the trigger for global deflation.
With strong encouragement of the IMF and World Bank, many Asian countries followed a three-pronged strategy for attracting foreign capital: liberalization of the financial sector (i.e. elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.
In retrospect, these countries exemplified the perils of "fast-track capitalism." Foreign capital entered in the form of short-term loans to banks and enterprises, but this speculative investment capital never found its way into the real economy of domestic manufacturing or agriculture—low-yield sectors that would provide a decent rate of return only after a long gestation period. Instead, the capital was invested into high-yield sectors with a quick turnaround time, such as the stock market, consumer financing and, in particular, real estate.
Outcome: A still-unresolved debate abouthow currency crises should be managed.
It was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown (financial contagion). It is also commonly referred to as the IMF crisis.
The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.[1]
Interestingly, Although the two events were unrelated, the collapse of the Thai baht on July 2, 1997, came only 24 hours after the United Kingdom handed over sovereignty of Hong Kong to the People's Republic of China. In October 1997, the Hong Kong dollar, which had been pegged at 7.8 to the U.S. dollar since 1983, came under speculative pressure because Hong Kong's inflation rate had been significantly higher than the U.S.'s for years. Monetary authorities spent more than US$1 billion to defend the local currency.
Stock markets became more and more volatile; between 20 October and 23 October the Hang Seng Index dropped 23%. The Hong Kong Monetary Authority then promised to protect the currency. On 15 August 1998, it raised overnight interest rates from 8% to 23%, and at one point to 500%. The HKMA had recognized that speculators were taking advantage of the city's unique currency-board system, in which overnight rates automatically increase in proportion to large net sales of the local currency. The rate hike, however, increased downward pressure on the stock market, allowing speculators to profit by short selling shares. The HKMA started buying component shares of the Hang Seng Index in mid-August.
The HKMA and Donald Tsang, then the Financial Secretary, declared war on speculators. The Government ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies,[20] and became the largest shareholder of some of those companies (e.g. the government owned 10% of HSBC) at the end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. The Government started selling those shares in 2001, making a profit of about HK$30 billion (US$4 billion).
The IMF created a series of bailouts ("rescue") packages for the most affected economies to enable affected nations to avoid default, tying the packages to reforms that were intended to make the restored Asian currency, banking, and financial systems as much like those of the United States and Europe as possible.
IMF intervention has been roundly criticized. The role of the International Monetary Fund was so controversial during the crisis that many locals called the financial crisis the "IMF crisis".[15] To begin with, many commentators in retrospect criticized the IMF for encouraging the developing economies of Asia down the path of "fast track capitalism", meaning liberalization of the financial sector (elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.[14]
IMF's Role in the Asian Financial Crisisby Walden Bello
The swift evaporation of the Asian economic "miracle" probably ranks second only to the unraveling of Soviet socialism as the greatest surprise of the last half-century. All at once, convention has been turned on its head as South Korea, Thailand and Indonesia line up for multibillion-dollar bailouts from the International Monetary Fund (IMF). Many of the same institutions and people who recently celebrated the Asian "tigers" as the engine of world growth into the 21st century now speak of them as a source of financial contagion, or, as the trigger for global deflation.
With strong encouragement of the IMF and World Bank, many Asian countries followed a three-pronged strategy for attracting foreign capital: liberalization of the financial sector (i.e. elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.
In retrospect, these countries exemplified the perils of "fast-track capitalism." Foreign capital entered in the form of short-term loans to banks and enterprises, but this speculative investment capital never found its way into the real economy of domestic manufacturing or agriculture—low-yield sectors that would provide a decent rate of return only after a long gestation period. Instead, the capital was invested into high-yield sectors with a quick turnaround time, such as the stock market, consumer financing and, in particular, real estate.
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