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

Revisiting the Financial Crisis: Sen. Michael Bennett Ignores Warnings

This is how clueless Sen. Robert Bennett was during the 2007 hearing of the Committee On Banking,Housing, and Urban Affairs. Bennett made this statement to Federal Reserve chair Ben Bernanke.

Senator BENNETT: And, by coincidence, I suppose the best rebuttal is in a piece that appeared in this morning’s paper by Brian Wesbury, who is the Chief Economist at First Trust Advisors, LP, in Illinois, ‘‘A Portrait of the Economy.’’ I would ask unanimous consent that the entire piece appear in the record.*

Chairman DODD: Without objection.

Senator BENNETT: He starts out, ‘‘It is the best of times. It is the scariest of times. Last year, U.S. exports, industrial production, real hourly compensation, corporate profits, Federal tax revenues, retail sales, GDP, productivity, the number of people with jobs, the number of students in college, airline passenger traffic, and the Dow Jones In-dustrial Average all hit record levels. For the third consecutive year, global growth was strong, continuing to lift and hold millions of people out of poverty. From 30,000 feet—heck, from 1,000 feet, it sure looks like the best of times. In relative terms, the first 5 years of the current recovery have been much better than the first 5 years of the 1990’s recovery. But this has not softened the pessimism of many pundits and politicians who are either unimpressed or expect the whole thing to come crashing down any minute, unless the Government firmly grabs the rein of the global economy and steers it clear of disaster.

And then he goes on to outline the history of how badly things have gone every time the Government has tried to step in and steer it clear, starting with the 1930’s and then the 1970’s. He makes this comment about the 1970’s, which I responded to, and it says, ‘‘Forgotten in the rush to pass judgment on capitalism is the fact that the last two times the Government seriously tried to control the economies in the 1930’s and 1970’s and made a terrible mess of it’’—well, I will leave the rest of it for people to read, but the one thing I would say to you, Mr. Chairman, if he is right—and I think he is—in the year of your stewardship, the last year, exports, industrial production, real hourly compensation, profits, tax revenues, retail sales, all are at record levels, you must have been doing a pretty good job. And if you were running for office, you would take full credit for absolutely all of it. Thank you, Mr. Chairman.

People were warning of an impending financial crisis and Bennett decided to treat this as utter nonsense. Bennett and other members of Congress can't say they weren't warned about a pending economic crisis. They heard these warnings and ignored them.

FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2007 by Michael Robert Hussey

David Stockman: Economic Anarchist

I wonder how much of the comtempt of the federal Reserve from Republican economic policymakers is rooted in the writings of Milton Friedman. Case in point is David Stockman.

A recurring theme of Stockman’s work is that it is precisely these efforts that have sown the seeds for all that ails the economy. He writes in the Times: “As the federal government and its central-bank sidekick, the Fed, have groped for one goal after another — smoothing out the business cycle, minimizing inflation and unemployment at the same time, rolling out a giant social insurance blanket, promoting homeownership, subsidizing medical care, propping up old industries (agriculture, automobiles) and fostering new ones (“clean” energy, biotechnology) and, above all, bailing out Wall Street — they have now succumbed to overload, overreach and outside capture by powerful interests.”

Friedman was highly critical of the Federal Reserve allow the dollar to deflate and not acting fast enough to stop the crash of 1929.

The first bank runs started in 1930. Banks did not have enough revenue to cover businesses and customers withdrawing money. Friedman is correct about the Federal Reserve acting too slow.

Friedman made it popular for conservatives to hate the Federal Reserve. However, Stockman argues that Friedman is wrong. Friedman rightly stated that the Federal Reserves not giving the banks a cash injection in 1929 was wrong. Stockman argues against the selling of Treasury bonds.

“During the four decades since the gold window was closed – the rules of the game have been profoundly altered. Specifically, under Professor Friedman’s contraption of floating paper money, foreigners may accumulate dollar claims or exchange them for other paper monies. But there can never be a drain on US monetary reserves because dollar claims are not convertible. This infernal regime of fiat dollars, therefore, has had numerous lamentable consequences but among the worst is that it has facilitated open-ended monetization of US government debt.” ibid.

Does Stockman actually want to go back to the gold standard? The man has lost his mind.

Hank Paulson, Tim Geithner and Ben Bernanke allowed Lehman Brothers to fall. The three even urged Lehman Brothers to file for bankruptcy. The result was an international economic crisis. International financial institutions froze credit after Lehman Brothers fell. Paulson went to Congress to get TARP passed and bailout AIG and the too big to fail banks. Stockman would have let AIG and the banks fail. The result would have been an economic crisis worse than the Great Depression. I am no fan of the way Paulson, Bernanke and Geithner handled the 2008 financial crisis. However, what Stockman is advocating is anarchy.

Question of the Day

Tim Geithner was president of New York Federal Reserve and Ben Bernanke was chairman of the Federal Reserve in 2008. President Obama appointed Geithner ad Treasury Secretary. Obama later reappointed Bernanke to the Federal Reserve in 2010. Was this Obama's "Brownie, you're doing a heck of a job" moment?

Why Bernanke Is Doing QE3

Federal Reserve chairman Ben Bernanke is begging Congress to do something about unemployment.

Our assessment and that of the research literature is that the polices we've undertaken have had real benefits for the economy, that they have provided some support, that they have eased financial conditions, and help reduce unemployment. All that being said, monetary policy, as I've said many times, is not a panacea. It's not by itself able to solve these problems. We're looking for policy makers in other areas to do their part. We'll do our part and we'll try to make sure that unemployment moves in the right direction but we can't solve this problem by ourselves."

The Do Nothing Congress went on recess without resolving unemployment for military veterans. Republicans killed the Veteran Jobs Corps bill. If Republicans don't want to create jobs for veterans coming back from Afghanistan and Iraq then what hope is there. Republicans also don't want Bernanke to enact QE3.

Mitt Romney

In a speech to New York City donors on Friday, Romney said in reference to QE3 that the course for America was to foster economic growth, not print more money.

"We're not going to have to look for the sugar high that comes with QE3 or QE4 or QE5 or QE6," Romney said, according to Bloomberg. "The real course ahead for America is to encourage the growth of our economy, not just to go out there and print more money."

I wonder if Romney paid attention to his economics courses when he got his MBA. Quantitative easing is the Federal Reserve buying assets, such as mortgage-backed securities, from major banks. The theory is the influx of cash in the market will help the economy and create hiring. Fiscally speaking, Bernanke is throwing a Hail Mary because Congress refuses to take action on unemployment. Republicans don't want to pass stimulus packages or QE3. There policy on unemployment is literally tax cuts for the top 1 percent and doing nothing else.

Why the Lame Duck Session is Important to Obama

Newt Gingrich went on cable news to show his compassionate conservative side. Gingrich declared unemployment insurance is "money for doing nothing." There are a lot of people not working because job growth has been miserable. The Department of Labor released the unemployment numbers. It ain't pretty.

The unemployment rate edged up to 9.8 in November, and nonfarm payroll was little changed (+39,000), the U.S. Bureau of Labor Statistics reported today. Temporary help services and health care continued to add more jobs over the month, while employment fell in retail trade. Employment in most major industries changed little in November.

This is why I laughed when Rick Scott said the Affordable Health care Act would be a job killer. Retail is affected when the economy takes a downturn. People have less money to spend. People get sick, regardless of economic conditions. Government money is being pumped into the private heal care system at a greater rate because of so-called Obamacare. The law will mandate millions of more Americans buying health insurance. This means more people getting check-ups and treatment. Scott didn't exactly turn down Medicare money when he ran Columbia/HCA. As the $1.7 billion fine levied by the Justice Department would indicate.

The lack of job growth has gotten so bad that Federal Reserve chairman Ben Bernake in quietly asking Congress to pass more stimulus. It is unheard of for a Federal Reserve chairman to advocate the passage of legislation.

Treasury Sec. Tim Geithner is negotiating with Republicans on extending the tax cuts. Given the way the Obama administration has been horrible at negotiating it would not be surprising if no unemployment extension is passed. Repubicans are playing chicken with the Democrats. Wanna guess which side will win?

Sadly, Democrats have poll numbers supporting extending unemployment benefits and letting the tax cuts for those making above $250,000 expire. Bloggers Joy-Ann Reid and Benjamin Kirby will stress that progressives must support Obama even though the president is allegic to policies progressives support. (Not an exciting GOTV message for 2012). Progressives should not support Obama when his fiscal policies hurt millions of Americans.

Right now Obama has American support for ending the upper-income bracket Bush tax cuts and extending unemployment. The Fedrral Reserve chairman is publicly backing more stimulus spending. The lame duck session is Obama's best chance to accomplish these legislative priorities and he is negotiating away his best opportunity. Things will only get worse when John Boehner officially becomes House Speaker.

If Republicans snatch victory when Obama has the advantage then the only reason to support him is because he is not a Republican. Obama has the offer more than not being Sarah Palin if he wants to get re-elected.

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.

Shiny Happy Economics Message

Jon Stewart makes fun of George W. Bush staging an optimistic economic press conference when Federal Reserve Chairman Ben Bernanke is giving Congress the bad news. Bush refuses to call the bailout of Fannie Mae and Freddie Mac a bailout. Bush told the White House press corp that the Treasury Deparment is only seeking approval of a bailout. Oh really.

The U.S. Treasury plan, which needs the approval of Congress, would extend credit to lend money to or buy stock in both Fannie Mae and Freddie Mac, the two companies that own or guarantee more than $5 trillion worth of U.S. home mortgages, almost half of the nation's total.

The move was necessary to restore confidence in the nation's financial system, but higher rates could be on the way as a result, Mike Smith, a banker with Sunset Mortgage in Bend, said Monday.

George W. Bush: Government action -- if you're talking about bailing out -- if your question is, should the government bail out private enterprise, the answer is, no, it shouldn't. And by the way, the decisions on Fannie Mae and Freddie Mac -- I hear some say "bailout" -- I don't think it's a bailout.

The Orwellian language from the White House never ends.