Sunday, August 13, 2017

"The secret history of the banking crisis"

From Prospect Magazine, July 14:
Accounts of the financial crisis leave out the story of the secretive deals between banks that kept the show on the road. How long can the system be propped up for?

It is a decade since the first tremors of what would become the Great Financial Crisis began to convulse global markets. Across the world from China and South Korea, to Ukraine, Greece, Brexit Britain and Trump’s America it has shaken our economy, our society and latterly our politics. Indeed, it has thrown into question who “we” are. It has triggered both a remarkable wave of nationalism and a deep questioning of social and economic inequalities. Politicians promise their voters that they will “take back control.” But the basic framework of globalisation remains intact, so far at least. And to keep the show on the road, networks of financial and monetary co-operation have been pulled tighter than ever before.

In Britain the beginning of the crisis was straight out of economic history’s cabinet of horrors. Early in the morning of Monday 14th September 2007, queues of panicked savers gathered outside branches of the mortgage lender Northern Rock on high streets across Britain. It was—or at least so it seemed—a classic bank run. Within the year the crisis had circled the world. Wall Street was shaking, as was the City of London. The banks of South Korea, Russia, Germany, France, Belgium, the Netherlands, Ireland and Iceland were all in trouble. We had seen nothing like it since 1929. Soon enough Ben Bernanke, then chairman of the US Federal Reserve and an expert on the Great Depression, said that this time it was worse.

But the fact that the tumult assumed such spectacular, globe-straddling dimensions had initially taken Bernanke by surprise. In May 2007 he reassured the public that he didn’t think American subprime mortgages could bring down the house. Clearly he underestimated the crisis. But was he actually wrong? For it certainly wasn’t subprime that brought down Northern Rock. The British bank didn’t have any exposure in the United States. So what was going on?

The familiar associations evoked by the Northern Rock crisis were deceptive. It wasn’t panicking pensioners all scrambling to withdraw their savings at once that killed the bank. It wasn’t even the Rock’s giant portfolio of mortgages. The narrative of Michael Lewis’s The Big Short, of securitisation, pooling and tranching, the lugubrious details of trashy mortgage dealing, the alphabet soup of securitised loans and associated derivatives (MBS, CDO, CDS, CDO-squared) tell only one part of the story. What really did for banks like Northern Rock and for all the others that would follow—Bear Stearns, Merrill Lynch, Lehman, Hypo Real State, Dexia and many more—and what made this downturn different— so sharp, so sudden and so systemic, not just a recession but the Great Recession—was the implosion of a new system not just of bank lending, but of bank funding.

It is only when we examine both sides of the balance sheet—the liabilities as well as the assets—that we can appreciate how the crisis was propagated, and then how it was ultimately contained at a global level. It is a story that the crisis-fighters have chosen not to celebrate or publicise. Ten years on, the story is worth revisiting, not only to get the history right, but because the global fix that began to be put in place in the autumn of 2007 is in many ways the most significant legacy of the crisis. It is still with us today and remains largely out of sight. The hidden rewiring of the global monetary system provides reassurance to those in the know, but it has no public or political standing, no resources with which to fight back if attacked. And this matters because it is increasingly out of kilter with the nationalist turn of politics.

In the wake of the crash and its austere aftermath, voters in many countries have pointed the finger at globalisation. The monetary authorities, however, have quietly entwined themselves more closely than ever before—and they have done so in order to provide life support to that bank funding model which caused such trouble a decade ago. Ten years on, the question of whether this fix is sustainable, or indeed wise, is a question of more than historical interest.
“To keep the show on the road, networks of financial and monetary co-operation have been pulled tighter than ever before”
In 2007 economists were expecting a crisis. Not, however, the crisis they got. The standard crisis scenario through to autumn that year involved a sudden loss of confidence in American government debt and the dollar. In the Bush era, the Republicans had cut taxes and spent heavily on the War on Terror, borrowing from China. So what would happen, it was asked anxiously, if the Chinese pulled the plug? The great fear was that the dollar would plunge, interest rates would soar and both the US economy and the Chinese export sector would crash land. It was what Larry Summers termed a balance of financial terror. America’s currency seemed so doomed that in autumn 2007, the US-based supermodel Gisele Bündchen asked to be paid in euros for a Pantene campaign, and Jay-Z dissed the dollar on MTV.

But somewhat surprisingly, like the nuclear stand-off in the Cold War, the financial balance of terror has become the basis for a precarious stability. Crucially, both Beijing and Washington understand the risks involved, or at least they seemed to until the advent of President Donald Trump. Certainly during the most worrying moments in 2008 Hank Paulson, Bush’s last Treasury Secretary, made sure that Beijing understood that its interests would be protected. Beijing reciprocated by increasing its commitment to dollar assets.

In 2007, it was not the American state that lost credibility: it was the American housing market. What unfolded was a fiasco of the American dream: 8.7m homes were lost to foreclosure. But the real estate bust wasn’t limited to the US. Ireland, Spain, the UK and the Netherlands all had huge credit booms and suffered shattering busts. As homeowners defaulted some lenders went under. This is what happened early on to predatory lenders such as New Century and Countrywide. Bankruptcy also came to the Anglo Irish Bank and Spain’s notorious regional mortgage lenders, the cajas. In the fullness of time, it was—perhaps, though not necessarily—the fate that might well have befallen Northern Rock too. But before it could suffer death by a thousand foreclosures, Northern Rock was felled by a more fast-acting kind of crisis, a crisis of “maturity mismatch.”...MUCH MORE
Here's a condensed version of events from a 2010 retrospective of our postings on what turned out to be just the tip-of-the-iceberg. By the way, when he first reported on the Bank of England emergency meeting Alphaville's founder and editor Paul Murphy bylined it "FT Alphaville" which explains why I didn't give credit for the 11:22 p.m. work ethic.

Golders Green branch of Northern Rock
 Depositors queue outside Northern Rock's Golders Green branch
 (around the corner, left)
The news in August 2007 had been bad, with Goldman CFO Viniar babbling about 25-standard deviation events.

The fall of Northern Rock was enough to tell anyone paying attention that something very bad was coming. The market went on to set it's all-time high on October 9, seemignly oblivious to what was happening in the credit markets.

Although the BBC's Robert Peston got the scoop, FT Alphaville bulldogged the story.
From the BBC:
21:03 GMT (22:03 UK)
Northern Rock gets bank bail out
I just happened to be in the office the evening of the 13th and apparently one of the FT Alphaville staffers happened to be at their office at 23:22 British Summer Time!
Here's the post, the first of many:
As a follow-up to the post immediately below.
Talk about a dynamic situation. Whatever happened to 3-6-3 banking?

From FT Alphaville:
All Chauffeur Alert! Bank of England Court convenes
It’s not the sort of invitation you’d turn down: 9.30 pm, Threadneedle Street, don’t be late. FT Alphaville understands that the governor, Mervyn King, his two deputies and the 16 non-executive members of the Bank of England’s Court of Directors convened on Thursday evening.
Needless to say, this will have been quite a confab, attendees ranging from Arun Sarin of Vodafone to Sir Callum McCarthy of the FSA, along with the in-house Bank team and the rest of the gang.
Top of the agenda, of course, was Northern Rock - known by another name to regular readers of Markets Live. News that the mortgage bank has had to seek emergency funding from its lender of last resort was broken by the BBC’s Robert Peston earlier in the evening.
But an All Chauffeur Alert? At 9.30? On a Thursday evening? Surely this must point to something more toxic - or at least something big and bad that we have yet to learn about. Rock is not a shock. The mortgage bank has been looking dangerously brittle for weeks, and when a share price falls by 3/4/5 per cent each and every day, people do tend to talk…
We are assured, however, that Rock is as far as it goes. For now.
The convening of the Council was a technical matter, required to sanction the launch of what is effectively a lifeboat.
Whether the threat of a run on Rock, and perhaps other overly ambitious mortgage lenders with synthetic balance sheets, will be treated as something technical remains to be seen.
So if you see one of these
Put it on.
Buy it.
The price of tin hats is going up
And from the Financial Times itself:
The Bank of England will on Friday throw a lifeline to Northern Rock by providing emergency funding to the beleaguered mortgage lender that has fallen victim to the liquidity squeeze in the banking sector.
In an unprecedented move, the Bank, working with the Financial Services Authority and the Treasury, will step in to bail out Northern Rock by providing it with a short-term credit line that will allow it to carry on operating.
The rescue, which has been approved by the Chancellor of the Exchequer, is the most dramatic illustration to date of how the British banking sector is being hit by the wave of turmoil that has paralysed the money markets....MORE at the FT.
On Friday the 14th it was a run on the bank:
Northern Rock: Customers line up to withdraw funds
The morning of Saturday the 15th:
Northern Rock (LON: NRK) Updates
When I read that The City's Stockbrokers and Fund Managers were queuing up to withdraw their deposits, well, it gets your attention....
I was so tired I degenerated to New York Post style headlines:
Rock, Paper, Scissored
Merrill Lynch came out with a buy rec. and a price target of 913 pence. Alphaville commented "We like a ballsy call, here on FT Alphaville, but what's this?
What's a Rock Worth? Lon: NRK; This Could be Awkward
More Post style headlines:
Panic on the streets of Britain: Northern rocked, City shocked 
On Sunday it just got silly:....

Thematically related this 2017 weekend:
"A big Wall Street firm bets the American Dream is dying"
"Volatility and the Prisoners Dilemma"—CBOE Risk Management Conference Asia, December 1, 2015
"...modern information technology is the cause of rising income and wealth inequality since the 1970's and has contributed to slow growth of wages..."