Former NY Fed Chief of Staff (under Tim Geitner and then later William Dudley) Mike Silva has written a very interesting new article about what happened during the 2008 financial crisis. I cover it here:
https://lonestarwhitehouse.blogspot.com/2019/02/inside-2008-financial-crisis-lessons.html
There is a lot of interesting material in this article. The article is written from the perspective of a direct eye witness to what took place. While it is somewhat self congratulatory as we might expect (we saved the world from a depression theme), it does illuminate us as to just how close we came to that very possibility (of course the public was not told this at the time) and it also notes that once a panic starts the only real solution they have is massive liquidity intervention by the Fed as lender of last resort. Interestingly, Mr. Silva offers this observation about why the Fed may not be able to "fix things" the next time around:
“Once a financial mob panics, the only thing that will end that panic is for a central bank with a large billy club to show up and announce: ‘Break it up everyone. Go home. This crisis is over.’” Unfortunately, the Dodd Frank Act (DFA) has crippled the Fed’s ability to play this role. I guarantee that curbing the Fed’s emergency authority will come back to haunt us."
Below are a few other selected quotes from the article:
-----------------------------------------------------------------------------------------------------------
"This was a terrifying moment. Central banks know how to support individual institutions, but no central bank had ever tried to support entire markets. And that was what we had to find a way to do. It was going to be up to a very small number of Americans sitting in conference rooms at the New York Fed, Board of Governors and Treasury Department to either figure this out, or not. As I looked out from the NY Fed at all the people walking around Wall Street not knowing how close we were to financial collapse, I silently prayed that my colleagues would find a way to avoid a second Great Depression. Then I got sick to my stomach."
WHAT LESSONS WERE LEARNED?
• RATIONAL BEHAVIOUR IS OVERRATED.
"A lot of economic, market and bank supervisory theory is based on the premise that financial actors are largely rational. The crisis convinced me that they are not. It was not rational for very experienced financial leaders to make their companies hostage to short-term financing that was, in the final analysis, secured by the irrational assumption that house prices will always go up. It was not rational for Dick Fuld to reject offers because their terms offended his pride. It was not rational for money market fund investors to flee all money market funds just because one fund made a bad bet. It was not rational for some lenders, at the height of the crisis, to stop accepting even Treasuries as collateral. The crisis convinced me that greed, ego, fear, short-sightedness, group-think and other human foibles have at least as much, if not more, to do with financial behaviour as rational thinking does. This presents a tremendous challenge that policy makers, economists and bank supervisors are going to have to come to grips with."
WILL THERE BE ANOTHER FINANCIAL CRISIS?
"Absolutely. As long as we have a financial system, we will have financial crises. The only question is how often and how severe. Personally, I think a crisis is likely to happen sooner rather than later because of the large number of possible crisis triggers that are currently being squeezed."
https://lonestarwhitehouse.blogspot.com/2019/02/inside-2008-financial-crisis-lessons.html
There is a lot of interesting material in this article. The article is written from the perspective of a direct eye witness to what took place. While it is somewhat self congratulatory as we might expect (we saved the world from a depression theme), it does illuminate us as to just how close we came to that very possibility (of course the public was not told this at the time) and it also notes that once a panic starts the only real solution they have is massive liquidity intervention by the Fed as lender of last resort. Interestingly, Mr. Silva offers this observation about why the Fed may not be able to "fix things" the next time around:
“Once a financial mob panics, the only thing that will end that panic is for a central bank with a large billy club to show up and announce: ‘Break it up everyone. Go home. This crisis is over.’” Unfortunately, the Dodd Frank Act (DFA) has crippled the Fed’s ability to play this role. I guarantee that curbing the Fed’s emergency authority will come back to haunt us."
Below are a few other selected quotes from the article:
-----------------------------------------------------------------------------------------------------------
"This was a terrifying moment. Central banks know how to support individual institutions, but no central bank had ever tried to support entire markets. And that was what we had to find a way to do. It was going to be up to a very small number of Americans sitting in conference rooms at the New York Fed, Board of Governors and Treasury Department to either figure this out, or not. As I looked out from the NY Fed at all the people walking around Wall Street not knowing how close we were to financial collapse, I silently prayed that my colleagues would find a way to avoid a second Great Depression. Then I got sick to my stomach."
WHAT LESSONS WERE LEARNED?
• RATIONAL BEHAVIOUR IS OVERRATED.
"A lot of economic, market and bank supervisory theory is based on the premise that financial actors are largely rational. The crisis convinced me that they are not. It was not rational for very experienced financial leaders to make their companies hostage to short-term financing that was, in the final analysis, secured by the irrational assumption that house prices will always go up. It was not rational for Dick Fuld to reject offers because their terms offended his pride. It was not rational for money market fund investors to flee all money market funds just because one fund made a bad bet. It was not rational for some lenders, at the height of the crisis, to stop accepting even Treasuries as collateral. The crisis convinced me that greed, ego, fear, short-sightedness, group-think and other human foibles have at least as much, if not more, to do with financial behaviour as rational thinking does. This presents a tremendous challenge that policy makers, economists and bank supervisors are going to have to come to grips with."
WILL THERE BE ANOTHER FINANCIAL CRISIS?
"Absolutely. As long as we have a financial system, we will have financial crises. The only question is how often and how severe. Personally, I think a crisis is likely to happen sooner rather than later because of the large number of possible crisis triggers that are currently being squeezed."
