By Any Means Necessary: The Fed’s Alphabet Soup is Born
We last left off in this little “mini-series” on September 17, which in 2008 fell on a Wednesday. The four successive days of September 14-17 saw the fall of Lehman Brothers, then Merrill Lynch, then AIG, and on Wednesday, the 17th, the near-death experience of Morgan Stanley and Goldman Sachs. The couple of days off since are not due to a calm, serene couple days back in the corresponding days of 2008. In fact, in the 72 hours after the initial batch of catastrophes, a slew of events took place, each one individually perhaps forgettable, but the composite milieu of which represented a stunning paradigm shift in national policy.
And we must reiterate, these were catastrophes that were caused by the financial crisis, not the cause of the financial crisis, and yet they served as perfect fodder for a negative feedback loop.
On September 18, 2008 (a Thursday that was following three brutal days), the Dow Jones Industrial Average rose 410 points (+3.9%) – making back much of the downturn of the day prior (but nowhere near the downturn of the whole week). The market had been flat throughout the day, up one minute, down the next, but trying to figure out its next move after a nearly thousand point drop the first three days of the week. I was glued to my computer screen, resisting all temptation to start heavily buying the market, believing [rightly] that things were just too unstable and uncertain to know exactly what to do just yet. I can’t even recall how many clients I spoke to on the phone that day, and I began sending email updates (bulk delivery) to as many clients as I could, as frequently as I could. I had sent the first of such electronic communiques the day prior as some clients were understandably petrified about what they were seeing on the news regarding Morgan Stanley (where their own funds were being held).
This practice of frequent “email updates” (largely to give more current updates to a greater number of people with greater efficiency) was absolutely born in this very week of the financial crisis, but it simply never stopped. Today, it is called Dividend Café, is a macro commentary covering all aspects of investing, and has over 4,000 subscribers worldwide. 🙂
With less than an hour left in trading on the 18th, markets unable to yet launch a comeback rally in the aftermath of recent bloodshed, Charlie Gasparino, famed markets journalist then in the employ of CNBC, jumped on air to say that he “was hearing reliable rumors of a massive, system-wide bailout being planned by Treasury Secretary Hank Paulson.” By the end of trading, we knew that President Bush had been visited by Fed Chair Ben Bernanke, Hank Paulson, and SEC chair Christopher Cox. The rough idea being floated was some mechanism by which the government could take some bad debt off the bank’s balance sheets. The market rallied violently, despite having no specificity of details, or certainty of passage. That lack of certainty around passage would come back to bite all parties in a couple weeks, and the lack of specificity of details would really become relevant. But for that hour, and into that market close, with credit markets still deeply clogged, and systemic uncertainty around the fate of Wall Street, investors bid up the market 4% out of the hope that Uncle Sam was coming to the rescue. By the week of October 6, the idea of nationalization potentially taking place would no longer seem so rosy – and would actually create one of the worst market weeks in America history. But for now, some signs of life were being perceived.
On Friday, September 19, markets started to get more clarity on what direction Ben Bernanke was willing to go in his leadership at the Fed. The Fed actually opened a guaranteed liquidity facility for banks and businesses that needed capital but had their “cash” in money market accounts that were temporarily broken. Never lacking for a clever name, the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF) was born (it rolls off the tongue). The idea that the banker of last resort, responsible for a stable monetary policy so as to stimulate full employment but stave off inflation, was now providing unlimited capital to businesses having trouble with their money market funds was stunning. It also may have saved the financial markets.
Of course, what the central bank was doing was working to inject liquidity, and the markets needed it, desperately. But what they could not do is inject solvency. At this point, the root of the crisis was the solvency of global financial powerhouses over-levered to an unfathomable degree. Backstopping money markets were not going to work.
From the days that followed, and in continued evolution in the time that passed, the Fed ended up launching a Term Auction Facility (TAF), a Primary Dealer Credit Facility (PDCF), and a Term Securities Lending Facility (TSLF). They also launched currency swap agreements with several foreign central banks outside the United States. By the end of the crisis, they had also launched a Commercial Paper Funding Facility (CPFF), Market Investor Funding Facility (MMIFF), and the Term Asset-Backed Securities Loan Facility (TALF). Alphabet soup was alive and well. All of these policy tools were essentially versions of injecting liquidity to banks and financial institutions (legal under the Fed charter if there was adequate collateral) or injecting liquidity directly to borrowers and investors (unheard of).
It is my opinion that in the days that followed Lehman’s bankruptcy, Ben Bernanke and Tim Geithner had an epiphany. Gone was the idea that this was a bad moment, but one that would pass after the market absorbed the loss of a couple big companies. In was the idea that these were unprecedented times, and would call for unprecedented action. Ultimately, the seriousness of Ben Bernanke’s resolve to place desperation over ideology would be demonstrated time and time again in the months and even years that followed, with “rules-based” central banking tossed aside, and a bazooka-like approach implemented. Good intentions in a time of pandemonium did likely give birth to some unpleasant monetary developments as well (QE3, Operation Twist, etc.).
But for now, in the third week of September 2008, something was happening minute by minute live on my TV, computer screen, blackberry, etc. The leading central banker in the world had gone from vehemently opposing Fed support to Lehman Brothers, to lending AIG $85 billion and taking over their company, to creating an alphabet soup of “facilities” by which questionable assets could get Fed support to keep the lights on. Hank Paulson and Ben Bernanke would begin begging Congress for additional support and powers. The Fed was moving into its own aforementioned liquidity powers. And Bernanke himself was admitting it was a “finger-in-the-dike” strategy.
I am not totally sure that Chairman Bernanke had much of a choice but to just go from one leak to the next by the time this fateful week arrived. Ultimately, the financial crisis was about to go down two different tracks – the fiscal side involving Congress and the taxpayers, and the monetary side involving Federal Reserve policy.
As Washington Mutual and Wachovia will tell us in our next two series contributions, we were living in unprecedented times. And Ben Bernanke was now up to speed.
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