donsutherland1

As the fallout from the bankruptcy of Lehman Brothers, anxiety related to the federal government’s rescue of AIG, and fatigue from a worsening Bear Market reverberated against the backdrop of a still dissipating real estate bubble, the table was increasingly set for an all-out panic. Perhaps all that was needed for a stock market crash was a trigger to begin an all-out run for the exits. Possible triggers included the failure of a new major financial institution in the U.S., the demise of a major European bank which would have indicated that the contagion that had sapped the American financial system was beginning to erode the pillars of Europe’s financial institutions, a complete seizing up of the overnight credit markets to the point a number of banks could not obtain the liquidity they needed to meet their capital requirements, or the start of capital flight from the U.S. by Asian investors.

The closing hours of trading on September 17 were particularly harrowing, as the Dow Jones Industrials went into a near-free fall that sent it to its lowest close since November 9, 2005, gold spiked by $80 per ounce, and a massive rush to quality in the form of Treasury purchases ensued.

The September 18, 2008 edition of The Wall Street Journal reported, “The desperation was especially striking in the market for U.S. government debt, long considered the safest of investments. At one point during the day, investors were willing to pay more for one-month Treasurys than they could expect to get back when the bonds matured. Some investors, in essence, had decided that a small but known loss was better than the uncertainty connected to any other type of investment.”

Overnight money markets experienced interest rate spikes on each day through Wednesday. The drying up of money had occurred during past panics and often sharp recessions followed. Not surprisingly, the Federal Reserve and five leading international central banks expanded their dollar-swap facility by $180 billion in a bid to inject sufficient liquidity into the money markets. In addition, at the Federal Reserve’s request, the Treasury deposited a fresh $100 billion in cash at the Federal Reserve.

That some of the nation’s best known financial institutions had succumbed to the continuing financial crisis, credit had suddenly become increasingly scarce, and Primary Fund RFIXX, a money market fund, saw its net asset value drop below $1 created the perception that refuge from the raging financial storm was hard to find. Not even money market funds offered such safety.

As the fear rose toward a climax, all kinds of dire prophecies were proclaimed. Edward Loef from Theodoor Gilissen Bankiers predicted that the Dow Jones Industrials could fall to 8,000 in the next month. Aaron Smith of Superfund Financial predicted gold would reach $1,500 per ounce in 2-3 years.

The following day, U.S. stocks gyrated wildly on each news story. Psychology not fundamentals had seized control of trading. By that time, the nation’s policymakers understood that a pragmatic solution to hold off the rising fear trumped ideological or political considerations. Toward that end, Treasury Secretary Henry Paulson announced consideration of a Resolution Trust Corporation-style entity that would buy up toxic mortgage-related securities. Although the RTC-type solution will come at a steep cost (estimates range from $500 billion to $2 trillion), policymakers recognized that the benefits of avoiding a systemic failure of the U.S. financial system with its worldwide contagion were preferable to political considerations such as the role of government. The market turmoil and Near Panic of ’08 had brought the debate over such a solution to a close.

Although the extent of the costs associated with those securities remains unknown, what had become certain was that the nation’s financial institutions were no longer confronted by the kind of uncertainty that had seen confidence in their viability erode at an accelerating rate. Stocks rebounded on the news. Another rebound is in order today.

In the weeks and months ahead, if things go reasonably well, money markets should slowly calm and interest rate spreads should narrow. The stock market may yet reach new lows down the road once the euphoria of yesterday’s and today’s likely rally fade, but prospects for a crash have lessened substantially. Investors can again focus on finding value—and there is still much value to be found in the United States. Those who take a chance will enjoy rewards.

The biggest risk of catastrophic failure going forward is whether the size of the RTC-style plan changes perceptions of U.S. creditworthiness. If the inflow of foreign capital begins slowing or even reverses, interest rates could rise sharply and a fresh crisis could emerge. Considering that the U.S. dollar is a reserve currency, one can reasonably expect that foreign investors will be careful to avoid triggering the kind of capital outflow that would precipitate a new financial crisis in the U.S. After all, the consequences of such a crisis would be felt worldwide. Hence, I believe prospects of such an outcome are low.

Therefore, the biggest immediate risk is again macroeconomic. A slow de-leveraging of the economy and an extended period of sluggish home prices prior to a bottom and then only slow recovery afterward, could undermine consumer spending. In turn, the risks of recession remain elevated from 2008 Q4 into at least the first part of next year. Odds of a near-term stock market crash, systemic financial system failure, and severe recession/depression are low.

Mentork

Government intervention saved the day?

SouthernDemocrat

Just like there are no Atheists in Foxholes, there are Libertarians in a Financial Crisis.

__________________
Charles Krauthammer describing Obama:

"He's got both a first-class intellect and a first-class temperament."

SFLRN

Government more or less (attempted) to save the day after it had helped create the problem in the first place. Little known fact (amongst the public), the U.S. government handed out subsidies to Fannie Mae and Freddie Mac to help them increase housing in the U.S. They then used these subsidies to ensure sizable profit margins in regular housing loans, creating a crowd out effect that encouraged more banks to take up these subprime mortages. Not to mention the refusal of Greenspan to raise interest rates for an exceptionally long time. Let's not forget U.S. fiscal policy that lead to the decline in the dollar (and thus the increase in the relative price of oil). Then there was the ethanol mandate which led to food costs going up (nicely aided by current agriculutral policy). Economies go through recessions. It's an inherent process. It happened with the IPO boom of the late 90s. There hasn't been a sustained recession in this country for years. It is a natural working of the market. The severity of this recession stems more from government than from the markets themselves. Does that mean there shouldn't be a way (or a reworking of regulations) so financial firms are more transparent, no. However, it is foolhardy to view this as simply an instance of market failure.

Mach

I can't believe I'm even reading that.
First of all, government is not to be generalized in this way. Government today is entirely different than it was 10 years ago, 10 years before that, etc. It's new people, new policies, new ideas, new markets, new players in the global economy, and so forth. Government can be efficient, or inefficient, can respresent everyone's interests or can address only a narrow group, etc. To generalize it is to politicize it, and that's not useful.


The fact is, de-regulation and attempts at more free market capitalism, or the emergence of new markets that are defacto not regulated, lead to the Great Depression, the S&L crisis, the current sub-prime crisis.

Naturally, an entirely free market will rise, and crash, and leave a ruined economy in its wake. That's human nature. Which people will then naturally rebuild. But as a nation, we're not OK with a catastrophic crash. That's inefficient, and deadly. If it's approached ethically, you set rules for playing in OUR marketplace, and those rules do not serve to limit growth, they serve to limit destructive growth, exhibited clearly in every bubble to date. Inadequate, irrelevant, or unenforced regulation is never a solution, so "regulation" is not the key. Appropriate and effective regulation is, along with a culture of responsible participation in such markets. Beating the drum of de-regulation is not OK. De-regulation is sometimes good, and sometimes deadly. Regulation is sometimes good and sometimes deadly. Not differentiating is always bad.

You have a choice. Set rules for playing the market place that ensures a more efficient and stable economy, and benefits everyone the same. Or let those on the cutting edge of the markets abuse the market, and let everyone else in the economy pay the loss, and fund the reconstruction.

even the general public that may know very little about economics, knows how games are played. With a game with good, sensible rules, it's fun, exciting, competitive, and worth playing and watching. If a game has loopholes, no rules, rules widely open to interpretation - it's no longer a game, it's just a chaotic free-for-all.

It's not a choice between government intervention or not. It never was. Government will intervene, and has historically, in every market in every nation. The choice is between irresponsible markets, or responsible markets. If I'm going to pay for it either way, I want to pay for a responsible market system.

-Mach

__________________
Let teachers and priests and philosophers brood over questions of reality and illusion. I know this: if life is an illusion, then I am no less an illusion, and being thus, the illusion is real to me. I live, I burn with life, I love, I slay, and I am content.- Conan

SFLRN

It (government) can be generalized about, as politicians act in a somewhat predictable manner. Government cannot represent everyone's interests in the full meaning of the word. Government can be efficient, historically, it is not. I'm not saying anything general about government, I have identified a number of areas where our most recent government has worsened our economic condition (this observation has been made by others with far more nuanced knowledge of the topics than I).
What did I specifically say about regulation, other than that there needed to be (depending on an analysis of the matter) more transparency in some form so information can flow more freely?

Regulations are less likely to prevent bubbles as they require specificity to stop a problem from arising. It's rather hard to see a problem when markets are in a boom period. If anything, the way to limit the severity of recessions and booms is to have a fairly responsible Fed (although I'm sure other ways exist that I have not yet considered). If one limits the amount of capital then they will limit the potential to over-invest. This strategy is of course beset by time-lags, and errors in economist's predictions. However, it is more likely to create an incentive structure rather than simply prohibiting practices (something that one will only do once the boom has turned into a trough, which is of course too late as the economy would suffer a loss regardless).
The reason there are loopholes is because the American public does not have the expertise nor the time to monitor the formation of very technical regulations. Corporate lobbyists do.
Do you have any refutation to the causes I listed earlier? My post really was not about regulation, and more about how in some ways government is likely to have contributed to the current crisis. However, this is an important issue to cover, but we should not overlook those previous assertions.

SouthernDemocrat

I worded this wrong:

Just like there are not Atheists in Foxholes, there are no Libertarians in a Financial Crisis.

donsutherland1

From the October 2, 2008 edition of The New York Times concerning the near panic that occurred on September 17-18:

http://www.nytimes.com/2008/10/02/bu...pagewanted=all

Ethereal

Oh hooray! Now we can keep spending money until the dollar becomes a more viable source of kindling than currency!

This country is going right down the proverbial toilet. Liberty, individuality, family, and community have been replaced by the supple teet of the government for which the collective's lips purse in infantile longing. I weep for the future...if we even have one.