Seven years and twenty days ago, there began a sequence of
terrifying events that changed financial history forever. Here's my diary of
the events as they unfolded, beginning on one of the most dramatic days of that
era.
* After weekend emergency negotiations collapse and the Fed
declines to participate in a bailout, Lehman Brothers, a Wall Street firm
heavily involved in high-risk derivatives transactions, files for bankruptcy.
* JPMorgan Chase, the nation's single biggest player in the
market for derivatives, puts up $138 billion to settle Lehman's outstanding
transactions. Nearly all of Lehman's other assets go into immediate liquidation.
* Merrill Lynch, the nation's largest brokerage firm, is
also suddenly bankrupt. It's abruptly sold to Bank of America in a shotgun
transaction engineered by the Fed.
* American International Group (AIG), the nation's largest
player in the derivatives markets among insurers, is also broke. But unlike
Lehman, it gets an instant $85 billion bailout from the Fed in exchange for an
80% interest in its shares.
September 16. A large money fund, Reserve Primary Fund, has
big losses in its short-term loans to Lehman. So its share price, which is always
supposed to be fixed at $1, suddenly falls below the all-important one-buck
level. Within 48 hours, the fund is swamped with a half-trillion dollars in
liquidation orders, and soon the contagion begins to spread to other money
funds.
September 19. To stem
the panic, the U.S. Treasury announces the equivalent of federal deposit insurance for money market funds,
transferring still more responsibility from
the private to the public sector.
September 21. In order to qualify for government support and
bailout funds, America's two largest investment banks — Goldman Sachs and Morgan
Stanley — decide, virtually overnight, to transform themselves into bank
holding companies.
Week of September 22. Congress starts to move swiftly to
develop an emergency bailout plan, draft legislation, get all the powers behind
it, and exert enormous pressure to suppress opposition.
October 3. The Emergency Economic Stabilization Act of 2008
is passed with a 263-171 bipartisan vote in the House. Almost immediately, $700
billion in bailout funds start flowing from the U.S. Treasury Department
straight into the coffers of giant U.S. banks on the brink of failure.
But it's just the first
of many actions around the world — mostly in the United States and
Western Europe — that help transfer more
trillions of dollars in toxic assets from the
books of bankrupt corporations to the books of federal governments.
October 7. The global market for short-term corporate IOUs
(commercial paper) has sunk into a sudden deep freeze.
This market is the oil that lubricates the industrial and
banking operations of the entire world.
Without it, the engine of the global economy grinds to a halt.
In response, the U.S. Fed announces a never-before-heard-of
"Commercial Paper Funding Facility." In other words, virtually any
major company in the world that cannot roll over its short-term debts coming
due is, in effect, invited to stop by the Fed's offices in downtown Manhattan
to pick up all the cash it needs.
Again, the ultimate responsibility for meeting huge amounts
of private-sector debt is transferred from the corporate sector to the
government sector.
October 8, 11 AM GMT.
It's rate-cutting time, and it's
big: Almost every major central bank in the world — including the U.S.
Fed, the Bank of England, the European
Central Bank, plus smaller banks such as the
Bank of Canada, Swedish Riksbank and the Swiss National Bank —
announce simultaneous, coordinated
interest-rate cuts of 0.5%.
For the Fed, it's the first leg of a 3-step move down to
zero percent.
But on the other side of the world, in Tokyo, it leaves the
Bank of Japan (BOJ) stranded, virtually alone. Why? Because the BOJ has already
cut its interest rates to zero long ago, and it has no more room to cut.
Ironically, for years, Japan's zero-interest policy has been
derided by every other self-respecting central banker in the West as
"foolhardy" or "amateurish." Now, they're all moving swiftly
through exactly the same gateway to the same "other world" — with no
plan regarding when or how to get back to normalcy.
Immediate result:
Despite the rate cuts, global stock markets plunge, and Japan is the
biggest loser, down more than 9% on the day. Long-term results:
* Seven years of zero interest rates.
* Three rounds of money infusions (QE1, QE2, and QE3) that
are a whopping 88 times larger than
during the Fed's prior emergency — to counter the economic paralysis in the wake of 9-11. (See "The Real Reasons Yellen Didn't
Raise Rates.")
* A virtually risk-free Garden of Eden engineered by the Fed,
driving global investors away from low-yielding safety toward higher-yielding risk
assets. And ...
* A series of speculative bubbles, including massive inflows
into junk bonds. (See "The Next Big Bubble to Burst.")
Most important of
all, since that fateful day seven years ago, all of the major governments of
the world have taken on an unprecedented
burden — not only as the biggest debtors on the planet, but also as the lenders of last resort for nearly
everyone else.
This is the great, hidden revolution of our times. And therein lies a powerful build-up of forces
that could unravel in ways that few investors understand. Good luck and God
bless! Martin
Source:
Money and Markets
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