Causes of the 2008 Financial Crisis

In this past year and especially the last two months; I have seen the Fed do things that I have never even deemed possible. There have been so many rules of fundamental economics that have been broken in the last 2 months that it is very hard to say what the actual constitutional powers of the US Fed is/are. I understand that these are unprecedented times but some of these actions and non-actions, I feel as though were not fully formulated. The Federal Reserve (Central Bank) was made so that the government would not be connected to the money supply, so that fiscal policy and monetary policy could work independently. It was an action to decentralize our government. I feel as though now this has been reversed and we are currently moving towards a more socialist/fascist society.

The best Federal Chairmen/Policy makers are ones that are credible and are able to maintain a level of predictability in the markets as to what policy will be in the future. This allows expected inflation and unemployment not to rise as much as if they were unpredictable and/or uncertain. This could be easily shown with a Phillips curve diagram; this brings me back to my point of fundamental economics and Bernanke’s disregard for noble prize winners and highly value economic tools. I believe that back in January when the Fed, made emergency rate cuts (.75 basis points) it completely disrupted the market. This spiked the future volatility index and issues of uncertainty and Bernanke’s level of credibility in the market.

I have always been taught the best chairman’s are the ones who everyone hates. At that point in time I feel as though Trichet was personifying the perfect chairman for the ECB. Furthermore, we saw all time highs in the euro, leading to an inflationary/energy bubble, which further worsened the American economy/outlook. Bernanke in my opinion, is a push over; he does whatever the markets tell him to do and does not use his fundamental economic models i.e. IS-LM-IP appropriately to see the effects of his policy making until recently. I remember reading the minutes of the March 2008 FOMC meeting and Bernanke explaining that this is a commodity driven recession. But we all know this was a collapse in the housing market and the deregulations of credit default swaps, etc. I believe Bernanke, actually made this matter worse, by cutting only the Fed Funds Rate so fast and not the discount window until recently makes no sense to me.

The inflationary bubble led to an energy bubble in which trillions have been lost by hedge funds and other speculators due to liquidations/redemptions etc; which further drove down the market. The huge rate cuts also helped increase the LIBOR rate, which almost all mortgages’ are tied to which in turn increased delinquencies’ of mortgage payments and further increased foreclosures, making credit even tighter, bank losses higher and essentially a very bad spiral. The only reason why we were not printing negative GDP was because our currency was so weak that our exports compensated for the other weak components of GDP. I feel as though rather than facing the problem head on, he has done nothing but delay/avoid it; it being a recession. This is where we are at now; the beginning of most likely a depression, high deflation and extremely high unemployment. Not once when we had very high inflation in the first two quarters of this year did Bernanke speak up at the G7 Meetings; with reference to currency and the possibility of intervention, in the form of pegging or buying back the dollar. It was well documented at the time by Bloomberg that there is a .97 correlation between the EUR/USD and Oil.

I just don’t understand how someone who claims this is a commodity driven recession can just sit back and let inflation explode. Not only that but his FOMC statements were very dovish making matters far worse. On the other side; Trichet stayed hawkish and stood his ground, he played the role and did his job. Even though it made since for him to cut rates because then inflation would actually decrease because the US dollar would appreciate and the price of oil being dollar dominated would go down, lowering the Euro-Zone inflationary levels.

Where has this brought us? We have a Fed Chairman, who claims to be an expert on the causes of the Great Depression yet it seems as though he may have actually just created his self -fulfilling prophecy. September, the introduction of TARPS; Bernanke had became so desperate because of the fact that he cut rates to soon and by too much that he had no ammunition to stimulate/stabilize the economy. Even at the congressional hearing Bernanke would not speak, he said very little if anything while Paulson did most the talking. I could tell Bernanke knew he screwed up big time and/or that we were in big trouble. He was breaking our constitution/his delegated powers, the very reason why his job was created essentially was unfolding in front of his very own eyes. This bill (TARPS), which was supposedly passed, on a Friday; which is what everyone on Wall Street was told was expected to boost the market. It ended up being defeated in the congress and cost the market 1.3 trillion dollars; another failure of the Bernanke regime.

Finally, after a week or so the bill is passed and Paulson and Bernanke are given a tranche of 350 Billion. It so happens that at this very same time almost all of Europe is also facing a financial crisis (U.K., Euro-Zone).Paulson and Bernanke decide to do direct capital injections into the banks. They had determined that the ability to price the MBS would be too difficult as they were packaged very complexly. I believe that these direct liquid capitalizations are no more than a form of a rate cut. They in essence do the same thing flood the money market and try to provide liquidity. It is just a different weapon the Fed is not supposed to have access to; the treasury. I believe Bernanke, learned from his lesson of the energy bubble and did the right thing with the coordinated worldwide rate cuts. This in effect neutralized the currency (worldwide) and purchasing power which kept inflation levels the same while at the same time providing the markets with capital. We also finally saw the lowering of the discount window.

I feel as though Bernanke was out to lunch, if the discount window was not 3.25% while Fed Funds rates were at 2% and he had not pushed LIBOR up to 4% by unexpected drastic rates cuts; I don’t think we would have needed to waste the 350-700 billion in direct capital injections to banks. I remember reading about how never had there been such a spread between the discount window and the funds rate until around march ’08. With the minutes of the Fed continuously changing economic outlooks, a chairman that has lost all credibility and predictability things will only get much worse until the new office takes over. There is also a high lack of transparency of where this bailout money is going, which further leads to the decrease in credibility of the Fed. Currently, as recent as November 10th, the fed loaned 2 trillion to undisclosed institutions. Which is well documented on Bloomberg’s website; the fed is currently being sued by Bloomberg for the rights to the information of who the loans were made to. I currently do not trust this government one bit. I believe they are entering uncharted waters. They gave away billions with no or very few rules outlined. Many banks have used this money for mergers, pensions, etc. The very three reasons we are where we are Credit Default Swaps, Foreclosures, and Credit availability all of which are becoming bigger problems as every new day passes. We are not attacking the root of the problem but are rather taking a wait and see what happens type attitude. Our monetary/fiscal discretionary programs are gone we are lost. Our very own government does not know what to do. As Paulson explained in his interviews things have changed, we have realized that the money would not be well spent by purchasing toxic assets. Some of the most successful billionaire investors say the government should just keep quite. In reality they are only making things worse, they have lost their credibility; they need to stop with their ambiguity and get back to stabilizing the economy and not disrupting it.

When we let Bearn Stearns fall which led to the collapse of AIG, then we realized we can’t let AIG fall, it’s as if we are one step behind in this; which is further making matters worse. What’s next? Will we let the car manufactures fall? And lose trillions of dollars in social surplus; when all we need to do is nationalize them, make Natural Gas cars like foreign countries and use our natural gas that the U.S. owns and drills for. Before this I had a lot of respect for my government, after watching this unfold I have realized that these politicians do not care about us citizens but rather only to be reelected. As far as the actions that are currently being taken place by the Fed, Treasury, Congress; I would have to conclude they are failing in almost all aspects. We have a huge deflationary problem on our hands, rather than doing what FDR did with gold; I believe we should have a G-20 Pegging of currencies, the dollar is gaining too much momentum, we will not have price, inflationary and unemployment stability until this is controlled. Furthermore, maybe the Fed should be the clearing house for these Credit Default Swaps, or the government should just nullify them. I also believe we must keep people in their homes, it costs the economy welfare to foreclose homes and from an economic standpoint. If are bailing out AIG; why can’t we just fix mortgage rates temporarily until the economy gets back on track, this will help stabilize the housing market and inflation, interest rates and prices etc.

I would like to also mention the last cut when Bernanke announced it the market funds rate was already below one percent. Never have I seen such divergence between the target rate of the fed and what the actual market is at or even seen CNBC show such a thing. This just an illustration of the lack of credibility/uncertainty in which he possesses. He set his target rate at one percent the market had already priced in .75% but this most likely had to be from the sums of money flooding the system. With a monetary policy which is ineffective, a chairman who keeps delaying the inevitable it can only get worse from here. Never in my life, have I been so upset with the government, why are we using stimulus packages? Any economist knows that a tax- cut has an ambiguous effect on GDP and interest rates. We are running a 1 trillion dollar deficit this year with nothing to show for it. Which I believe is highly understated. Furthermore, I conclude that on all fronts for which the fed is responsible for; Objectives, Instruments, and Channels we are failing. This is just the beginning of what could be the worst depression America has yet to face.

Works Cited:
• Press Releases/ Statements: Primary source:
• Analysis of statements in calendar portion: Primary source Wall Street Journal