Revisiting the Financial Crisis: Meeting of the Federal Open Market Committee on September 16, 2008 Part 1

The Federal Reserve has finally released the minutes of the Federal Open Market Committee after Lehman Brothers filed for bankruptcy. William Dudley opened with a briefing on the current economic status. The Fed did an overnight repo (repurchase agreement) to put money back in the market. The stock market ended up losing half its value during the following five months. Dudley was too optimistic about the repos.

To try to have more effect on this issue, this morning we came in much earlier than we normally do—around 8:00 a.m. We did a $50 billion overnight repo. The funds rate at the time was trading at 3¼ percent. I think this means that we are obviously adding way too many reserves for the current maintenance period; but the good news is that, when this maintenance period is over a week from tomorrow, we get a fresh start. So at the current time I think we will see essentially a lot of firmness in the funds rate in the morning and then the funds rate trading down to zero late in the day. Where the funds rate averages relative to the target is going to be somewhat difficult to say. Yesterday, despite the collapse in the funds rate to essentially zero at the end of the day, the funds rate was quite firm relative to the target. I don’t remember the numbers, but it was in the 2½ percent range. We are going to try to hit the target on average, but it is going to be very difficult. In the current circumstances, it probably is more sensible—at least my advice would be—to err on the side of providing enough liquidity to the market rather than trying to be cute and worrying just about the target federal funds rate.

The Fed was buying the repos to give a quick fix to cash strapped financial institutions. The banks would agree to buy to repos back at a greater interest.

According to Bloomberg News, Lehman Brothers used repos to hide the true worth of the investment bank. Lehman was essentially lending money to itself through Hudson Castle Group Inc. This was legal under the law. Lehman pledged the notes to Hudson Castle as collateral to JPMorgan Chase & Co. The notes were essentially worth nothing.

Dudley told the Committee that Goldman Sachs and Morgan Stanley were at risk. Investors feared that Goldman Sachs and Morgan Stanley could go under like Lehman Brothers.

Now, the Lehman filing has also intensified the pressure on Morgan Stanley and Goldman Sachs in a number of respects. The Lehman failure means that investors now view the debt of Morgan Stanley and Goldman Sachs as having much more risk than it did on Sunday. This means that these firms need bigger liquidity buffers than they had before, and it does have implications for long-term profitability. As a consequence, their share prices fell very sharply yesterday. Morgan Stanley was down about $5 a share, to $32, and Goldman Sachs’s stock was off 18 points, to $135. Morgan Stanley experienced a modest, but not insignificant, pulling back of their counterparties and ate into their liquidity buffer by a measurable degree.

If no one wants to do business with Goldman Sachs or Morgan Stanley than they will quickly run out of money. Banks only keep about ten perfect of their revenue. The rest of the money loaned or invested out. Banks make their money from collecting interest from their various deals. THe problem is this creates a problem for the banks if there is an economic crisis.

Dudley correctly told the committee that AIG presented a bigger crisis to the financial institutions. People that bought to collect on credit default swaps they bought in the event of Lehman Brothers assets failing. Dudley told the Committee that AIG doesn't have the money to repay the on the swaps their clients bought.

Of course, we also have the issue of AIG. The AIG problem is at least starting as a liquidity crisis. The problem with AIG is that the parent company doesn’t have a lot of liquidity resources and doesn’t have easy ability to funnel liquidity up from their subsidiaries because most of the subsidiaries are regulated entities. So AIG is running into two problems: One, they are unable to roll their commercial paper and, two, as their ratings are downgraded—they were downgraded by Moody’s yesterday, I think from AA minus to A minus, but don’t quote me on that—they have to post a lot more collateral against their derivatives exposures and also with respect to their GIC (guaranteed investment contract) business. So AIG is in a situation in which the parent is basically going to run out of money—today, tomorrow, Thursday, or very, very soon. Now we say it’s a liquidity thing, but a lot of times when people look closer at the books they find out that the liquidity crisis may also be a solvency issue. I think it is still a little unclear whether AIG’s problems are confined just to liquidity. It also may be an issue of how much this company is really worth.

What Dudley is actually saying here is that Eurupean banks were freezing out the major American investment banks.

This would reassure people that dollar liquidity was available in Europe throughout the European day. My advice to you is that this is probably a good idea in this environment because we are seeing that the lack of dollar liquidity in Europe is really having a feedback effect on people’s willingness to do business with one other in the broader markets.

The Committee agreed to swap dollars for Euros with the European Central Bank and other parties. Donald Kohn did not want this recorded in the minutes. Ben Bernanke agreed with Kohn.

CHAIRMAN BERNANKE. Why don’t we have discussions with our counterparties—we won’t announce anything today, I would assume?

MR. DUDLEY. No, I think they have to take it up the chain of command, just as we do here. So it’s going to take probably a day.

MR. KOHN. This would come out in the minutes for this meeting.

CHAIRMAN BERNANKE. Right. We’ll announce something.

MR. STERN. But I assume there will be an announcement at some point.

CHAIRMAN BERNANKE. Of course. When would we announce this measure?

MR. DUDLEY. I think it would be after we’ve had a chance—I mean, I think we have a lot of work to do with our foreign counterparties. This was basically raised to me this morning.

Dudley was concerned that the dollar would not be available in Europe. Jeffrey M. Lacker felt that the ECB was attempting to hoard dollars because of the economic crisis. I think both Dudley and Lacker are right.

MR. LACKER. Note here a sense of discomfort with our lending them dollars that they already have and so our serving as a substitute for their mobilizing their own dollar reserves for this purpose. Obviously, the demand could swamp their own reserves, and at that point I would feel differently about this. But my understanding is that the distribution within the European system of central banks is uneven, and in some sense this just provides them with a way to circumvent negotiating how those dollars would be distributed from different central banks to different private-sector banks within their own system. Broadly, I’m uncomfortable with our playing that role.

The short answer is banks all over the world were going to the Federal Reserve for a line of credit.

Bernanke signed off on the Euro swap deal with Europe because he was concerned about the dollar weakening in Europe.

There is another action item I would like to add, given what is happening, which is that there are very significant problems with dollar funding in other jurisdictions—in Europe and elsewhere.

Later in the meeting, Lacker was talking about raising interest rates. On what planet was he living on.

I can support standing pat with the funds rate today. I think that’s a good idea. I think, looking forward, that we will want to raise rates sooner rather than later if core inflation doesn’t moderate.

The Federal Reserve ended up keeping interest rates near zero in response to the great recession. The Federal Reserve ended up dropping interest rates to 1 percent on October 29, 2009.

The labor market was already weak when Lehman filed for bankruptcy. Economist Dave Stockman provides a bleak picture to the Committee. Unfortunately, Stockman thought the unemployment numbers might get better.

The other notable development over the intermeeting period has been the weakness in the labor markets—now not principally in the payroll employment figures. Private payroll employment has been falling pretty sharply but not any faster than we would have thought. But the rise in the unemployment rate is remarkable. Now, some of the 0.4 percentage point increase in the unemployment rate last month could be statistical noise. It wouldn’t be entirely surprising to see it fall back some. But the more than 1 percentage point rise that we’ve had since April is not going to be statistical noise. Some of that increase probably reflects a bigger response to the emergency unemployment compensation program than we previously thought, and we’ve upped our estimates for that to a little less than 0.3 percentage point on the level of the unemployment rate. But even putting that aside, we have experienced a more significant rise in the unemployment rate, and I think that’s consistent with other things that we’re seeing in terms of the labor market data. We’ve seen another appreciable jump in initial claims. Announced job cuts are up. Job openings are down. Survey hiring plans have softened.

Stockman thought there was a chance for the housing market to recover in 2009. Boy, was he wrong.

The three things that are absolutely central to producing that outcome are our projection that we’re going to get a stabilization in housing in 2009—and early in 2009; that there will be some diminishment of the drag on growth from the financial turbulence; and that oil prices flatten out. Of those three, to my mind, the component that probably is most central and most important would be seeing some stabilization in the housing market, not only because this has been a big drag on growth and will also have consequences for household wealth but also because if there’s going to be some clarity and reassurance to financial market participants, it seems as though some end to the housing debacle has to be in sight. We think we are seeing a few glimmers of hope there—however, we thought that on occasion in the past and have been proven wrong. But sales of existing homes have been flat since the turn of the year. Sales of new homes have been flat for several months now. We’ve had a drop in mortgage interest rates that followed the takeover of Fannie and Freddie. Starts have fallen so much now that, in fact, builders are making significant progress in working down the inventory of unsold new homes and even months’ supply has tipped down of late. So we think that some things are looking a little better for us there. As a consequence, we’re expecting to see some bottoming-out near the end of this year or the beginning of next year—but not a sharp recovery. Overall residential investment actually is still a negative for 2009 but less of a negative than it has been this year.

This chart by Business Insider show foreclosures increased in 2009. Banks went into overdrive on foreclosing on homeowners. JPMorgan Chase was forced to pay $13 billion for the illegal mortgage practices of Washington Mutual.

Meeting of the Federal Open Market Committee on September 16, 2008 by Michael Robert Hussey

John Carney Wants Treasury to Tax Itself

The stupidity of CNBC columnist John Carney is beyond words. Carney believes that 234 million shares of AIG stock to avoid paying a higher capital gains tax next tax year.

One question that comes to mind is whether the timing of this sale of the last of the Treasury's stake in AIG allowed the Treasury to avoid rising capital gains taxes in 2013. In 2013, when the law that temporarily lowered capital gains rates expires, the rates on long term capital gains are set to rise from 15 percent 20 percent. Lots of investors are attempting lock-in gains now to avoid paying the higher rate. Did the Treasury just do the same thing?

Carney then goes on to cry about the Treasury Department being tax exempt. The harsh injustice of it all. What Carney fails to realize that on the AIG share sale the point is moot. The IRS is part of the Treasury Department. Carney cries about Treasury not paying capital gains taxes on the AIG sale. If Treasury did pay taxes on the AIG sale it would just collect the money back through the IRS.

The stupidity of the people that work at CNBC amazes me.

The Gas Commission

Three months from now we won't hear anything about the Gas Commission investigation. Anyone really believes the Justice Department will prosecute an energy company. There hasn't been a major SEC investigation of any of the major financial institutions involved under President Barack Obama's watch. These companies needed bailout money because they hid their losses through off-the-books accounting practices. The New York Federal Reserve withheld announcement of a AIG credit swap exchange with.

"Do you think it might be feasible to hold off on the Maiden Lane III 8K and press release until next week?" Brett Phillips, a New York Fed lawyer wrote in an e-mail [to AIG counsel]. "The thinking is that the Maiden Lane III closing will be a less transparent event, and it might be better to narrow the gap between AIG's announcement and the New York Fed's publication of term sheet summaries."

Former New York Reserve chairman Tim Geithner was paying AIG 100 cent on the dollar of taxpayer money. No interest was charged. Geithner then went on to become Treasury Secretary.

I have no faith in the Obama administration cracking down on energy companies.

Update: another reason I doubt the White House will crack down is because it purposely sent out bogus numbers on the BP spill.

On 4 August, Jane Lubchenco, the NOAA administrator, demanded that the White House issue a correction after it claimed the "vast majority" of BP oil was gone from the Gulf.

A few days earlier, Lisa Jackson, the head of the EPA, and her deputy, Bob Perciasepe, had also objected to the White House estimates of the amount of oil dispersed in the gulf. "these calculations are extremely rough estimates yet when they are put into the press, which we want to happen, they will take a life of their own," Perciasepe wrote.

The financial crisis and Gulf spill gave the White House the opportunity to do the right thing. The White House felt protecting corporate interests is more important than the environment or taxpayers. The Obama administration bleeds neoliberal. People should stop kidding themselves that Team Obama is most concerned about the people.

Sen. Shelby Wants to Gut Financial Reform

Richard Shelby would most likely become chairman of the Senate Committee on Finance if Republicans take over the Senate. Shelby made it clear to ABC News that he plans to gut the Financial Reform bill.

"The bill is so sweeping and such a game changer in many ways that it's incumbent upon us to revisit it," Shelby said at the Reuters Washington Summit.

Yes, things were working so well before. That is why taxpayers were left paying for the bank bailout. Financial institutions were taking huge risks with naked credit default swaps. AIG sold too many naked CDS. AIG was unable to pay all the financial institutions that bought CDS. AIG nearly went under and other troubled financial institutions could not get the CDS revenue owed to them.

Federal Reserve Chairman Ben Bernake and Tresury Sec. had this revealing conversation about AIG.

On Wednesday, September 17th, a day after the Fed agreed to inject eighty-five billion dollars of taxpayers’ money into A.I.G., Bernanke asked Paulson to accompany him to Capitol Hill and make the case for a congressional bailout of the entire banking industry. “We can’t keep doing this,” Bernanke told Paulson. “Both because we at the Fed don’t have the necessary resources and for reasons of democratic legitimacy, it’s important that the Congress come in and take control of the situation.”

Shelby wants to maintain the status quo.

"I don't believe it's good for business, it's not good for the financial sector and ultimately I don't believe it's going to be good for credit for a lot of people who need it. It's gonna cost," Shelby said.

I have no problem with the free market and people making money. My concern is systemic risk that could cause a depression. There is a difference between encouraging free market growth and reckless financial practices. Shelby would be encouraging the latter.

Shelby has set his sights on the newly created Consumer Financial Protection Bureau.

"The consumer agency bothers me the most," said Shelby, who failed to reach a compromise with Democrats and voted against the bill. "I thought the creation of it and the way it was created was a mistake," he said.

Notice Shelby didn't offer an alternative to make sure that consumers aren't vulnerable to shady financial practices. It is absolute insanity for Republicans to think different results will be achieved using the same faulty financial practices.

Shelby saves his most wingnuttery attack for Elizabeth Warren.

"I believe she's got a big ax to grind and she's sharpening that ax," said Shelby. "I don't think that you need somebody in a position like that with all these preconceived ideas and I believe she has a lot of them."

Warren is serving the American people and not special interests. Warren hasn't been afraid to put Treasury Sec. Tim Geithner in the hot seat. Sen. Chris Dodd has been against Warren's nomination. Warren is scaring members of both political parties. She must be doing something right.

Reality

Is This Change?

Treasury Sec. Tim Geithner has funneled repaid bailout through AIG to pay Goldman Sach's naked credit default swaps. Repaid bailout money was suppose to be given to community banks to loan out to small businesses.

The President increased the Defense Department budget by 4 percent.

The White House has been against Sen. Chris Dodd's attempts to reform the Federal Reserve. The current administration desperately wants to protect the status quo of the financial and insurance sectors that caused the recession.

So must for "change." I know we are in a economic crisi but it would be nice if Obama pretended to care about spending. Actual caring is another matter.