The Panic Vortex, 10 Years Later: What’s Changed?

Posted On Sep 14, 2018 By Dave Gonigam

  • Americans’ household income still below pre-Panic of 2008 levels
  • Meanwhile, the too-big-to-fail banks are rolling in it
  • The arsonists of 2008 demand more powers for “financial firefighters”
  • Counterfactual: What if the crisis had gotten the 1920–21 treatment?
  • Censored news of 2008 that the elites couldn’t possibly suppress now
  • What will the next crisis look like? Whatever it is, grab the pitchforks

Pitiful: Income in the typical American home still hasn’t clawed its way back to where it was before the “Great Recession” kicked in a decade ago.

This week, the Census Bureau released its annual report on household incomes. The mainstream headlines said the median figure in 2017 — that is, half the households made more, half less — was $61,372.

Adjusted for inflation, median household income grew 1.8% from 2016 — the third straight year of increase. All good, right?

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Ah, but wait! The Census Bureau changed its methodology in 2013. We won’t take you into the weeds, other than to say the chart is misleading. The Economic Policy Institute reruns the numbers each year for an apples-to-apples comparison. Turns out median household income remains 0.1% below 2007 levels.

We bring up the comparison today… because tomorrow marks the 10th anniversary of what’s regarded as the most panic-ridden moment from the Great Recession, the panic vortex, as it were. On that day, Lehman Bros. went under. Merrill Lynch nearly went under until the feds arranged a shotgun marriage with Bank of America. The giant insurer AIG was likewise circling the bowl. And so on…

Compared with median household incomes, the market cap of the biggest bank in the land has fared much better in the last decade.

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OK, to be fair we should probably adjust the number for inflation. But even then, JPMorgan Chase has grown 158% in size during the past decade. In 2015, we noted that CEO Jamie Dimon’s net worth crossed the $1 billion mark — in all likelihood a first for a bank executive. (Hedge funds and private equity are way more lucrative.)

We’re not singling out JPM. It’s only one among many “too big to fail” institutions. We use it as an example for reasons we’ll come around to later…

“The jerks got away with it!” wrote David Dayen at Salon — for a fifth-anniversary retrospective in 2013.

“The financial crisis featured a group of self-styled innovators who thought they devised perfect financial instruments that would only yield big returns and never any losses (in reality they did devise that, only it’s called ‘the United States government’).”

Heh…

Says Agora Financial contributor Nomi Prins, a recovering investment banker who began her career at JPM, “The Lehman collapse catapulted the Federal Reserve on a mission to, in its own narrative, save the economy from further collapse.

“In fact, its creation of $4.5 trillion to purchase U.S. Treasury and mortgage-related bonds from the big private banks in exchange for continued liquidity was the biggest subsidy in U.S. history.”

Yup. The Fed became the proverbial “lender of last resort” — an idea given life by Walter Bagehot, the English businessman and writer who was editor of The Economist magazine during the 1860s and 1870s.

The “Bagehot rule,” as it’s come to be known, says that in times of crisis, central banks should lend freely…

  • to solvent institutions
  • against good collateral
  • at penalty rates of interest.

During our own retrospective in 2013, we observed the Fed and Treasury didn’t just break the Bagehot rule; they ran it through a buzz saw, doused the remnants with kerosene and set them alight. The Fed’s alphabet-soup rescue programs — they went by acronyms including TSLF, CPFF and TALF — funneled billions of dollars…

  • to dead-ass broke banks
  • which put up garbage for collateral (if anything at all)
  • and paid a pittance for interest.

The too-big-to-fails emerged on the other side even bigger, JPM included. “The bank is, and was, as highly connected to the Fed then as it is now,” Nomi says. “Jamie Dimon was a class A director of the New York Fed when the Fed began its strategy of providing zero-cost money to the banks as well as its quantitative easing [money printing] program.”

But enough maudlin reminiscing. Let’s look ahead. Or maybe down — into the abyss…

“What We Need to Fight the Next Financial Crisis,” said the presumptuous headline of a New York Times Op-Ed last weekend.

Its authors are three of the people we daresay are most responsible for fomenting the crisis — former Federal Reserve chairman Ben Bernanke, ex-Treasury Secretary Hank Paulson and New York Fed chief-turned-Treasury Secretary (after Paulson) Tim Geithner.

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The terrible troika in 2008: Oy, remember how panicked Paulson always looked?

Their gist was that there’s not enough government/Fed authority to bail out the banks again.

“[I]n its post-crisis reforms, Congress… took away some of the most powerful tools used by the FDIC, the Fed and the Treasury. Among these changes, the FDIC can no longer issue blanket guarantees of bank debt as it did in the crisis, the Fed’s emergency lending powers have been constrained and the Treasury would not be able to repeat its guarantee of the money market funds.”

Oh, the poor dears. Somebody call the whaaaaambulance!

It gets better: “The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular. But if that unpopularity delays or prevents a strong response, the costs to the economy become greater. We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration.”

Said the arsonists of 2008.

The terrible troika did not address an alternative course that would have also been “politically unpopular” but would have had a far better outcome for everyday Americans.

As the nation was gripped by a depression after World War I, President Warren Harding… sat on his hands and did nothing. The Fed uncharacteristically stood aside, too. Events were allowed to run their course. The system was purged and cleansed.

It was painful as hell… but the depression of 1920–21 was over in 18 months. Unemployment fell from 12% in 1920 to 6.7% by late summer 1921… and 2.4% by 1923.

Imagine for a moment what would have happened if Bush and Obama and Bernanke had done likewise.

Actually, our own macroeconomic maven Jim Rickards did just that in his book The Death of Money. “The year 2009 would have resembled 1920 in the severity of its depression, with skyrocketing unemployment, collapsing industrial production and widespread business failure.

“But an inflection point would have been reached. The government-owned banks could have been taken public with clean balance sheets and would have exhibited a new willingness to lend. Private equity funds would have found productive assets at bargain prices and begun investing. Abundant labor, with lower unit labor costs, could have been mobilized to expand productivity, and a robust recovery, rather than a lifeless one, would have commenced.”

Here’s one thing we know will be different during the next crisis.

We rewind again, this time to the events of Sept. 17, 2008 — two days past the panic vortex.

Financial Times columnist John Authers says news broke that day which he and his fellow members of the power elite withheld from us peons.
The night before, a money market fund called the Reserve Primary Fund “broke the buck” — its share price falling below the money-market custom of $1. The fund’s exposure to Lehman was just too great.

Suddenly one of the “safest” financial instruments out there looked positively perilous.

“This was a run on the bank,” Authers writes. “The solvency of Wall Street’s biggest banks was in question.”

That much information was public. What follows was suppressed.

Fearing the “contagion” effects, Authers went to his nearest Citi branch in Midtown Manhattan to pull some of his money out. “I found a long queue, all well-dressed Wall Streeters. They were doing the same as me. Next door, Chase was also full of anxious-looking bankers… All I needed was to get a photographer to take a few shots of the well-dressed bankers queueing for their money and write a caption explaining it.”

But he did not. “Such a story on the FT’s front page might have been enough to push the system over the edge,” he writes. His competitors made the same call.

Think about it: Ten years on, with ubiquitous smartphones and social media, the elites could not possibly suppress that news now.

For his part, Authers says the risk to the system nowadays doesn’t lie in the banks but rather with pension funds. There won’t be any lines for anyone to take pictures of.

We’re not so sure. Just four big banks — JPMorgan Chase, Citi, Goldman Sachs and Bank of America — hold $185 trillion in “derivatives.” Those are the exotic securities like forwards and swaps that Wall Street uses to juice its returns. Warren Buffett once called them “financial weapons of mass destruction.” Derivatives were central to the Panic of 2008.

A decade ago, going into the teeth of the crisis, those four banks’ derivative holdings totaled $168 trillion. So the number is higher now.

As it happens, JPM has issued at least two reports we’re aware of — trying to divine what the next crisis might look like.

One report is positively benign — anticipating a 20% slide in the stock market, perhaps during 2020. By comparison, the S&P 500 plunged 54% from October 2007–March 2009.

The other report is much more dire. It expects a bear market so bad that the Fed’s post-2008 remedies wouldn’t be enough. Next time, the Fed would have to print money to buy not just bonds, but also stocks.

That might sound crazy to you, but the Bank of Japan and the Swiss National Bank — among others — have done it for years.

The report begs the question of whether the Fed could blow up its balance sheet again without shattering confidence in the dollar. As we suggested last year, there’s no guarantee on that score.

But leaving that question aside, the report contemplates some other disturbing consequences of the Fed buying stocks. JPM’s Marko Kolanovic avers that “This may be controversial in light of the potential impact of central bank actions in driving inequality between asset owners and labor…

“In fact, many recent developments such as the U.S. presidential election, Brexit, independence movements in Europe, etc., already illustrate social tensions that are likely to be amplified in the next financial crisis.”

Here’s the translation from stilted and awkward banker language: People gonna be feelin’ pitchforky.

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If the Fed buys stocks during the next crisis…

In December 2004, Agora Financial posted a report with the cheeky title The Total Destruction of the U.S. Housing Market.

Our researchers uncovered an internal Fannie Mae document revealing the firm’s exposure to derivatives. Our report was so provocative that Fannie pulled the document off the web and fired the schlub who wrote it.

Seven months later in July 2005, the aforementioned Ben Bernanke was interviewed on CNBC and asked to tease out the consequences if housing prices were to tumble.

His reply: “Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis.” As late as March 2007, he said the trouble in subprime mortgages was “likely to be contained.”

To this day, Bernanke successfully hides behind a “nobody saw it coming” defense… while collecting hundreds of thousands of dollars a pop in speaking fees.

For our part, we’re looking around for what will prove the catalyst for the next big crisis. So far it eludes us.

A few analysts claim the existence of an “everything bubble,” but that’s just lazy. The bubble is always something very specific — housing (2008), dot-com stocks (2000), junky “assets” held by savings and loans (1990)…

Whatever proves to be the catalyst for the next crisis, we can assure you of three things…

  1. We’ll see it coming here at Agora Financial before the politicians and central bankers do.
  2. The politicians and central bankers will in fact have contributed to the crisis.
  3. The politicians and central bankers will demand, and seize, more power to address the crisis they helped cause and didn’t see coming.

We’ll keep looking for the catalyst. It’s bound to turn up eventually. As soon as we spot it, you’ll be the first to know.

Have a good weekend,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

P.S. The markets today? Not much happening. The August retail sales number was a bummer, though. We’ll follow up with anything significant on Monday. Stay safe if you’re in Hurricane Florence’s path.


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